100 percent mortgage financing: USDA rural home loans

You might not know that the U.S. Department of Agriculture (USDA) is in the mortgage business, but they are. Rural housing programs allow people with very low to moderate incomes buy houses with no down payment and, in some cases, subsidized interest rates. And in case you're wondering, it's important to note that not all "rural" areas are way out in the boonies. There are some that are pretty close to major metropolitan areas.

What mortgages does the USDA offer?

The USDA operates the Guaranteed Loan program, the Direct Loan program and the Mutual Self-Help Housing program; all work slightly differently from one another, but have some common guidelines.

One of its most popular programs is an insurance program that guarantees 30-year fixed-rate mortgages offered to moderate-income buyers by private mortgage lenders.

USDA-guaranteed loans are popular because no down payment is required and there are no monthly mortgage insurance premiums. With USDA loans, underwriting guidelines are similar to those of the Federal Housing Administration (FHA) -- that is, the guidelines can often be more flexible than those for conventional loans.

USDA loan guarantee program is self-funding
For most of its existence, the USDA loan program was funded by annual appropriations from Congress, but this meant that the program occasionally ran out of money or was otherwise tripped up by the budgeting process. That was remedied in July 2010 with Public Law 111-212, which made the USDA Rural Development agency's guarantee program independent of annual legislative funding.

Since then, the USDA's loan programs have been self-funded by a fee charged to borrowers. This arrangement is similar to the FHA program, where mortgage insurance premiums collected from borrowers keep FHA's program afloat with no taxpayer money involved.

The USDA program can charge borrowers an up-front fee of up to 3.5% of the loan amount, but the USDA can lower this cost by imposing an annual fee of up to 0.5% of the outstanding balance annually. These fees change from time to time as the funding needs of the program change.

Currently, the up-front guarantee fee is 1% of the loan amount being borrowed, and there is a 0.35% annual fee charged for the life of the loan.

Not all lenders offer USDA-backed loan programs

USDA Rural Development housing loans are not made by just anyone at any mortgage lending company. Originating USDA loans requires special knowledge and training, and only a small percentage of loan officers have it. In addition, many mortgage lenders choose not to deal with rural housing loans because they don't do much business in rural areas or don't want to assume the risk of underwriting these mortgages.

If you're shopping for a mortgage lender that funds USDA rural housing mortgages, you may need to speak to a number of companies before you find one that offers the program. To find one in your area, the USDA has a state-by-state list of USDA lenders that participate in the USDA-RD program.

The USDA also posts a list of lenders that are most active in the program.

Before you shop for a USDA home loan

If 100 percent financing or a subsidized interest rate appeals to you, learn a little more about the various programs offered by the USDA, as well as the borrower and property requirements.

It's important to note, for instance, that the USDA's 100 percent financing is determined by the property's appraised value, not the sales price of the home.

Qualifying for USDA loans

Both you and the property you want to purchase must be qualified for a USDA-backed loan. For you, there are household income limits based on the Area Median Income (AMI) in the location where you hope to purchase. The USDA's Guaranteed Loan Program allows you to make up to 115 percent of the location's AMI, while their Direct Loan Program has income limits defined as either or low income (50% to 80% of AMI) or very low income (below 50% of AMI). See USDA income limits by area.

The USDA uses debt-to-income ratios of 29% and 41%. This means that the maximum amount of your monthly gross income (MGI) that can be used for housing-related costs (principal, interest, taxes, insurance and more) is capped at 29% of your MGI, but your total debt-to-income ratio (which includes payments on credit cards and other loans) is allowed to be as high as 41%.

USDA loans don't actually have a required minimum credit score, but lenders offering these loans typically require a credit score of 640. Credit scores below 640 may be considered if there are other acceptable credit uses that aren't in the borrower's credit history but can be documented as being paid as agreed.

In addition to this, the property you are buying must be in an eligible rural area. That said...

USDA defines rural areas generously

What is rural? You'd be surprised. The USDA defines "rural" generously -- you don't have to buy a home in the farm belt to qualify. In fact, the vast majority of the land area in the U.S. falls within this definition of rural. The rural designation includes many small- to medium-sized towns as well as suburban areas outside larger cities. The USDA offers a USDA property eligibility lookup tool to determine a given property's eligibility.

However, if you don't have a specific property in mind, but rather are looking in an area or region for a new home, the tool allows you to zoom in on an area by using the scroll button on your mouse, so you can see dividing lines between eligible and non-eligible area.

If the property you want to buy is an an eligible rural area, it will still be subject to maximum loan limits for that area. You can see a state-by-state list of USDA Loan Limits, which are updated annually.

Basic USDA House Guidelines and Requirements

To qualify for these loan programs, the home must be modest in size, design and cost. Modest housing is determined by what is typical for homes in the area and generally does not exceed 2,000 square feet above grade; its market value cannot exceed the applicable area loan limit, and it can't include buildings principally used for income-producing purposes.

Updated property guidelines note that an existing home with an in-ground swimming pool may be considered modest; however, in-ground swimming pools with new construction or with properties that are purchased new are prohibited. Previously, existing homes with in-ground pools were ineligible.

Houses constructed, purchased or rehabilitated must meet the national model building code adopted by the state and thermal and site standards set by the USDA's Housing and Community Facilities Programs (HCFP). Manufactured housing or mobile homes must be permanently installed and must meet the Department of Housing and Urban Development's Manufactured Home Construction and Safety Standards as well as HCFP's thermal and site standards.

USDA Guaranteed Loan program overview

The Guaranteed Loan program is funded through USDA-approved mortgage lenders and brokers. Like the FHA program, the USDA doesn't directly fund these loans itself but instead guarantees them, making them a safer investment for the lenders. These loans come with no subsidies -- you find the best deal you can from a mortgage lender and pay the going rate.

The Guaranteed Loan program guidelines allow applicants earn up to 115 percent of the median income (AMI) for the area after certain adjustments. A good loan officer who specializes in USDA and other government mortgages should be able to help you determine if you qualify.

You can also do an income self-assessment using the USDA eligibility tool; Load the page, locate and click on "Single Family Housing Guaranteed", then click on "Income Eligibility" and select your state and county and fill in the fields as required.

Summary:

• The USDA GLP guarantees home loans through private lenders for the purchase of modest housing in designated rural areas.
• Income qualification is up to 115 percent of area median income for the same size household.
• No down payment is required.
• Loans are fixed-rate mortgages with 30 year terms.
• Funds can be used for repairs and to cover the funding fee.
• There is no monthly mortgage insurance payment (PMI).
• The home must be the borrower’s primary residence.

Locate a USDA GLP Lender in your area.

USDA Direct Loan program overview

To be eligible for a USDA Direct Loan, your income can't be more than 80 percent of the median income for the area. These loans can be used to build, repair, renovate or relocate a home, or to purchase and prepare a building site, including providing water and sewage facilities.

The Direct Loan program is funded directly through the USDA Rural Development agency, and monthly payments may be subsidized -- the goal is to keep mortgage payments between 22 percent and 26 percent of the applicant's gross monthly income.

The interest rate is set by HCFP based on the government's cost of money. Loan terms are 33 years, except for borrowers who earn less than 60 percent of the area median income, who can have terms of up to 38 years to make the loan more affordable.

Since these USDA mortgage loans are directly written and funded by the USDA, applications are accepted and processed through local Rural Development Service Centers. Each state page has full details for the Direct Loan program, updated interest rate information for it and contact information.

Summary:

• Lends funds directly to low- and very low-income families to purchase modest homes in rural areas.
• "Low-income" is defined as income between 50 and 80 percent of the area median income, and "very low-income" is below 50 percent of the area median income.
• Loan terms can be 33 or 38 years.
• Funds can be used to build, repair, renovate or relocate a home, or to purchase and prepare home sites.
• Payment assistance can lower the loan’s effective interest rate to as low as 1 percent.

Other USDA home loan programs

The USDA offers other homeownership programs, too.

The Mutual Self-Help Housing program makes homes affordable by allowing would-be homeowners to work on homes themselves. With this "sweat equity," each buyer pays less for his or her home. Qualified applicants are required to complete 65 percent of the work to build the home.

For very low-income families who own homes needing repair, the Home Repair Loan and Grant Program (also called the Section 504 Home Repair program) offers loans and grants for necessary renovations and maintenance.

The Home Repair Program also provides funds to make a home accessible to someone with disabilities -- for example, to build a ramp for someone using a wheelchair. Other qualified repairs include fixing a leaking roof, adding central heating or replacing an outhouse with a bathroom.

Homeowners 62 years and older are eligible for home improvement grants. Other low-income families and individuals can get loans with 1 percent interest rates directly from Housing and Community Facilities Programs (HCFP).

See Details and eligibility requirements for MSHP/Section 504 home repair loans.

These loans and grants are made available directly from local USDA offices.

Gina Pogol contributed to this article.