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How Does a USDA Mortgage Loan Work?

One of the most important steps in the home-buying process is choosing the right type of mortgage. While many homeowners opt for conventional loans, there are a handful of alternatives, including loans backed by the U.S. Department of Agriculture. There are some advantages to taking out a USDA loan, but it may not be right for everyone.

Who’s Eligible for a USDA Loan?

The USDA loan program is available to both first-time and experienced homebuyers. To get approved, you’ll have to meet your state’s income guidelines. Depending on the median income level in your area and the number of people living in your household, you might qualify for either the guaranteed housing loan or the direct loan for low-income families.

Aside from income restrictions, the home you’re buying has to be your primary residence. Most importantly, the home has to be located in an approved rural area. The USDA’s definition of what counts as rural is fairly broad so you may be able to qualify even if you live within the limits of a small town or an outlying suburb of a larger city.

How Much Can You Borrow?

How Does a USDA Mortgage Loan Work?

There’s no set dollar amount limiting what you can borrow through the USDA loan program, but your mortgage amount is capped based on your income and debt. Typically, it’s a good idea to keep your monthly mortgage payments – along with any other debt payments you have – to about a third of your income. The USDA may increase the borrowing ceiling if you have a higher credit score and financial assets, such as a savings account.

Does the USDA Issue the Loans?

Like an FHA or VA loan, USDA loans aren’t actually granted by the federal government. Instead, if you end up defaulting, the lender is able to get some of the money they’ve fronted back.

Because USDA loans are so different from other types of mortgages, they’re not offered by every lender. While certain larger banks, like SunTrust feature USDA loan programs, they’re not available in every state. The Department of Agriculture maintains a list of approved lenders on its website.

What Are the Down Payment Requirements?

How Does a USDA Mortgage Loan Work?

One of the things that makes a USDA loan an attractive financing option is the fact that you don’t have to put any money down to close the deal. That’s a plus for lower-income buyers who may not be able to cough up a bunch of cash all at once.

The trade-off is that you’re required to pay mortgage insurance for a USDA loan. Currently, there are two mortgage insurance payments buyers are responsible for. The first is a payment equal to 2% of the loan amount, which is due at closing. The second is a monthly mortgage insurance premium that’s 0.4% of the loan balance.

Who Should Apply for a USDA Loan?

The USDA loan program is ideal for someone who wants to buy a home, but may not have a lot of money to spend on closing costs or a down payment. As long as you’ve got a credit score in the mid-600 range and you meet the other eligibility requirements, getting approved for a USDA loan may be easier than trying to snag a conventional mortgage.

Photo credit: ©iStock.com/Tongshan, ©iStock.com/Kritchanut, ©iStock.com/TARIK KIZILKAYA

Rebecca Lake Rebecca Lake has been writing about the nuts and bolts of personal finance for nearly a decade. She is an expert in investing, retirement and home buying topics. Her work has been featured on The Huffington Post, Business Insider, CBS News, U.S. News & World Report and Investopedia. As a homeschooling mom of two, she's always looking for ways to make the most of every dollar.
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