With the uncertainty surrounding today’s mortgage market and skyrocketing prices to buy real estate, buyers are having to come up with more and more cash to cover the costs of closing and buy-down their interest rates.
As of the time of this writing, the average interest rate on a 30-year mortgage is 5.95%. By comparison, two-years ago that same mortgage had an interest rate of 3.13%, according to the Federal Reserve Bank of St. Louis. This spike in rates has priced many would-be homebuyers out of the market. It also adds the extra burden of buying down the interest rates when they are simply too high for a reasonable monthly payment.
Regardless of your individual situation, buyers low on cash to close can look to a USDA loan as the solution to achieving homeownership.
What is USDA Loan?
A USDA mortgage is a loan that is backed by the United State Department of Agriculture and it has arguably the greatest incentive for borrowers to utilize this type of funding – zero down payment. This incentive helps level the playing field in this current market and allows buyers to be more aggressive with their offers to purchase a home or buy-down their interest rates.
Advantages of an USDA Loan
USDA loans also benefit those borrowers who have average or fair credit. In most cases, lenders will want to see a 640 credit score, but some will go down to as low as 580.
Similar to FHA mortgages, these loans are backed by the USDA which means they are less risky for lenders and often have rates lower than that of conventional mortgages. According to the St. Louis Fed, today’s USDA rate is around 5.59%.
There is also no prepayment penalty for a USDA mortgage and many closing costs can be financed into the loan. This makes this loan very attractive for individuals looking to keep the most amount of cash in their pocket after closing. In fact, a seller can pay all the closing costs associated with the mortgage as there is no minimum borrower contribution required for USDA to guarantee the mortgage. Many buyers will utilize this feature and make an offer on a home that includes closing costs financed in the mortgage.
A USDA loan isn’t only for U.S. citizens either. According to the USDA, if you’re a permanent resident, non-citizen national, or a qualified alien you can also apply for this type of mortgage.
Disadvantages of an FHA Loan
While a USDA loan offers borrowers many unique advantages, they are not without drawbacks. The biggest challenge for a USDA borrower is finding a home that is within the qualified geographic area for financing.
A USDA loan is for homes in “rural” areas and the organization has implemented certain areas where you can purchase a home using its loan program. There are several interactive maps you can use to determine if the home you are wanting to buy is an eligible property. You can use this link to verify the properties eligibility: https://eligibility.sc.egov.usda.gov/eligibility/welcomeAction.do.
The other large obstacle to overcome when selecting a USDA mortgage is making sure you meet the income limit requirement. The USDA establishes a 115% area median income limit for the entire household, not just the person paying applying for the mortgage. For example, if the area median income for the region the property is located in is $60,000, the entire household income cannot exceed $69,000.
Much like FHA and conventional loans, these loans have mortgage insurance (MI) regardless of whether you use the zero down option or put down as much as twenty percent. For a USDA loan, you’ll have an upfront guarantee fee and an annual fee (billed monthly) that serves in the same capacity as MIP on FHA loans.
However, USDA mortgages MI is significantly less than FHA or conventional mortgages. By comparison, an FHA upfront mortgage insurance premium is 1.75 percent of the loan amount while USDA’s guarantee fee is only 1 percent. The monthly MIP for FHA is calculated by your total loan balance multiplied by .85 percent and divided by 12. In contrast, the MI for USDA is calculated the same, but with an annual fee charge of only .35 percent.
While the USDA annual fee and upfront guarantee fee is cheaper than other loans, you will have to pay the annual for entire life of the loan. The only way to get rid of the annual fee is by refinancing your mortgage.
Additional drawbacks to a USDA mortgage are more strict appraisal guidelines – sometimes scaring off sellers from accepting offers with USDA financing – and property types. In most cases, USDA loans must be for single family homes. Condominiums and townhomes are allowed on a case-by-case basis. The home must also be your primary residence meaning no second home or investment property uses are allowed.
The Verdict
Given the vast flexibility a USDA loan affords a buyer when it comes to closing cost and the fact that there isn’t a down payment required, it should be seriously considered when comparing your loan options. This type of financing not only can save you a lot of money that is typically required in purchasing a home, but also helps those with low to moderate income finally achieve their dream of homeownership.