USDA Construction Loans: A Comprehensive Guide for 2024

With a USDA loan, you can buy a home in an eligible rural area with zero money down and a government-backed interest rate that’s likely lower than most other mortgages. But what do you do if you can't find any properties that fit your needs and meet the USDA's guidelines for approval?

In some scenarios, the best answer may be to build your own home using a USDA construction loan to finance the entire process.

This comprehensive guide to USDA construction loans will go over everything you need to know about financing your rural home build in 2024, including precisely how a USDA one-time construction loan works, the eligibility requirements you need to meet, and a few alternative mortgage options you may have available.

Key Takeaways

• A USDA construction loan allows you to buy land and build a brand-new home with 0% down in eligible rural communities.

• Your USDA one-time construction loan automatically converts into a permanent mortgage once work is complete.

• Your loan can include nearly all costs related to acquiring land, building a home, and financing the project.

• Only specific USDA lenders offer new construction loans, so some borrowers may have difficulty finding one in their area.

• Alternatives to a USDA construction loan include single-close options through conventional, FHA, and VA lenders and traditional two-closing loans.

What Is a USDA Construction Loan?

The USDA construction loan program is designed to help low-to-moderate-income borrowers build brand-new homes in eligible rural communities.

This could be someone:

• In a rural area with few existing homes for sale

• With needs that currently-listed properties do not meet

• Who already owns land and wants to move onto it

• Who wants to personally customize their dream home

With a USDA one-time construction loan, you can purchase land, finance the construction of your home, and automatically transition into a permanent mortgage once work is complete.

Best of all? USDA loans offer 100% start-to-finish financing for your home construction.

Keep in mind that while USDA single-close construction loans allow you to buy land, you must have certified and approved plans to build a home on it. You cannot use this USDA loan to purchase and hold onto vacant or undeveloped properties.

How the USDA Construction Loan Works

The USDA construction loan simplifies the process of financing a new home build. While most construction loans require you to refinance into a permanent mortgage after finishing the work, the USDA program offers a single-close construction-to-permanent solution.

This means that you only have to do one closing – and only pay for one set of closing costs – which can shave thousands of dollars off your total expenses and eliminate the risk of interest rate changes or financial issues occurring before you can refinance into a long-term loan.

With the USDA new construction loan program, you’re able to purchase a homesite, fund all of the improvements and construction costs, and then automatically convert it into a 30-year fixed-rate mortgage with pre-agreed terms once the property is move-in ready.

What the USDA Construction Loan Covers

USDA construction loans are one of the few zero-down payment methods for building a brand-new home. In most cases, you can use the loan to cover just about all residential construction costs.

Land Costs

You can use your single-close construction loan to cover the entire cost of purchasing land for your home or to pay off the mortgage on suitable land you currently own.

If you already have land debt-free, you can still use a USDA construction loan to build a home – you are not obligated to purchase property as part of the transaction.

Hard Construction Costs

Hard construction costs include all the expenses outlined in the builder’s construction budget, which generally accounts for labor and materials.

Other hard construction costs that you can include in your USDA construction loan are:

• Well and septic system installation

• Grading or finishing roads and driveways

• Hooking up utilities

• Landscaping the property

• Additional types of necessary contributive work

Soft Construction Costs

Soft construction costs comprise most other expenses and fees associated with borrowing and homebuilding. The USDA also allows you to include these items in your loan.

The soft construction costs you’re likely to incur include:

• Appraisal and inspection fees

• Project review fees

• Survey fees

• Permit plan review fees

• Architectural and engineering fees

• Builder fees

• Lender admin fees

• Contingency reserves

• Interest reserves

• PITI payment reserves

• Other reasonable and customary expenses

USDA Construction Loan Requirements

Qualifying for a USDA single-close construction loan isn’t all that different from applying for a traditional mortgage. You still need to meet standard USDA eligibility guidelines with a few additional construction-specific requirements.

All USDA Loans

The following requirements apply to all USDA-backed loans:

• Properties must be in a USDA-approved rural location.

• Homes must be modest in size, typically under 2,000 square feet, and considered appropriate for the area.

• You must plan to live in the home as your primary residence.

• The property must be appraised and meet minimum program standards.

• Total household income must not exceed the maximum limit in your area for your household size.

• The USDA does not specify a minimum required credit score, but most lenders look for a score of 640+. However, finding lenders accepting applicants with lower credit may be possible.

• You need a debt-to-income (DTI) ratio of 41% or lower, although lenders may accept DTIs up to 44% with positive compensating factors.

USDA Construction Loans

On top of basic USDA eligibility, here are some other specific USDA construction loan requirements:

• Homes can be site-built, modular, or manufactured housing.

• Projects must be built following certified plans and specifications.

• Construction has to meet or exceed the current International Energy Conservation Code (IECC).

• Work must be completed by a builder or general contractor who meets USDA standards.

• Homes must come with an acceptable builder warranty.

USDA Contractor-Builder Requirements

All builds must be completed by a builder or general contractor who meets the standards outlined by the USDA:

• They must have two years of experience handling all aspects of single-family construction required for the proposed project.

• They must have a state-issued contractor or construction license, as the applicable jurisdiction requires.

• They must carry general liability insurance with a minimum coverage of $500,000.

USDA Loans for Constructing Community Facilities

Are you hoping to use a USDA construction loan to build something other than a single-family home? The USDA has various programs designed to construct community infrastructure in approved rural areas.

Some of the uses for the USDA community facilities programs include building:

• Health care centers

• Educational facilities

• Public safety services

• Child and adult care centers

• Other types of community-based initiatives

However, these programs differ greatly from the residential construction loan program covered in this guide. Community facilities loans are typically only available to public entities, nonprofit organizations, and federally recognized Native American Tribes.

USDA Construction Loans vs. Other Construction Loans

USDA one-time construction loans aren't the only single-close option that borrowers have available for building a new home. In addition to government-backed loans insured by the FHA and VA, lenders also offer conventional construction loans, which typically have fewer restrictions.

FHA One-Time Construction Loan

The FHA one-time construction loan program requires a 3.5% down payment from borrowers with a credit score of 580 or higher. Applicants with scores between 500 and 579 may be able to secure funding with 10% down.

The qualification process for an FHA mortgage is generally more relaxed than with a USDA construction loan. Credit score minimums and other borrower standards are usually lower, and more lenders offer the FHA-backed program.

However, fees tend to be higher with the FHA, and ongoing mortgage insurance premiums could very well result in more expensive monthly payments.

VA One-Time Construction Loan

Open to active-duty service members and honorably discharged Veterans, the VA one-time construction loan is a 0% down program, much like the USDA's. While there is a funding fee similar to the USDA upfront guarantee (that is more costly for most borrowers), there is no ongoing mortgage insurance or annual fee.

Even though VA construction loans can be a great option for qualifying borrowers, very few lenders offer them, so finding one in your area may be just as difficult as a USDA construction loan.

Conventional One-Time Construction Loan

Conventional lenders offer single-close construction loans that adhere to conforming mortgage standards. For most borrowers, a conventional construction loan requires a minimum down payment of at least 5%.

Borrowers with lower credit scores may incur high private mortgage insurance costs. However, PMI is only required with less than 20% equity. If you already own the land you plan to build on, you can apply its value to your equity calculations.

Two-Closing Construction Loans

Using a two-closing construction loan means taking out one loan to purchase property and build a home and then refinancing it into a separate permanent mortgage once construction finishes and you're ready to move in.

Finding a lender offering standard construction loans is much easier than a USDA single-close mortgage. However, you’ll likely be required to have a sizable down payment. You must also fully requalify when refinancing into your long-term loan.

The greatest downsides of two-closing construction loans are that you have to pay for your closing costs twice – which can run 2% to 6% of your loan balance, depending on the loan time you're using – and that negative changes to your credit or finances could leave you at risk of being unable to refinance into a permanent mortgage.

USDA Construction Loan Pros and Cons

A USDA new construction loan can be a great way to build your perfect home without the hassle and costs of taking out multiple mortgages to complete the project. However, there are some downsides to the program worth considering as well.

Pros of a USDA Construction Loan

Some of the most common reasons why rural buyers opt for a USDA single-close construction loan include:

• Building a Home With 100% Financing – While other popular single-close construction loans require a minimum of 3.5% to 5% down, the USDA program offers a zero-down-payment homebuilding experience.

• No Requalifying Once Construction Is Complete – Traditional two-close construction loans require you to requalify for a new mortgage once work is complete, adding additional closing costs and the potential risk of being denied your refinance. Single-close financing eliminates these extra costs and added risk.

• Flexible Credit Score Requirements – Although most construction loan programs have fixed credit score requirements, USDA guidelines do not specify a minimum borrower score. Lenders set their own credit requirements, and while many look for a score of 640 or higher, it can be possible to find USDA financing with scores in the 500s.

• Set Interest Rates at Closing – With a traditional construction loan, there's a potential for interest rates to change drastically between the start and finish of the project. If interest rates rise, you may wind up with far greater monthly payments than you budgeted for when refinancing. Interest rates for USDA construction loans are set at closing before building begins, removing this risk.

• USDA Vetted and Approved Builders – While there is no way to guarantee the quality of a builder’s work, the fact that the USDA must approve all companies and general contractors helps to reduce the risk of using one that's underqualified or disreputable.

Cons of a USDA Construction Loan

Although the pros may sound pretty convincing, here are some cons of a USDA construction loan:

• Must Build in an Approved Rural Area – While an estimated 97% of US land is located within USDA-approved areas, cities and many suburban communities are ineligible. This could mean building further from towns and population centers than you'd prefer.

• Offered by Only a Few Lenders – Not all lenders offer USDA construction loans. In fact, few companies currently handle these types of mortgages. Depending on your area, finding a lender willing to approve your build may be difficult.

• Cannot Oversee Construction Yourself – USDA guidelines require you to hire a professional builder or general contractor to manage your project. Even if you are licensed and meet the other USDA contractor requirements, you cannot oversee construction on your home.

• Upfront Guarantee and Ongoing Annual Fees – All USDA mortgages have an upfront guarantee fee of 1% paid at closing or wrapped into your total loan balance. You are also responsible for a 0.35% ongoing annual fee that begins as soon as you close on your loan.

• Paying Interest Costs During the Construction Phase – Even though your full mortgage payments won't begin until your home is move-in ready, you are still obligated to pay interest costs accrued during construction. Some buyers make monthly payments, while others wrap the costs into their new mortgage.

How to Get a USDA Construction Loan

Getting a USDA one-time construction loan is slightly more complex than getting a standard mortgage. There are more moving parts when building a new home, and many different parties must work together to keep everything on track.

Here’s what to expect when applying for a construction-to-permanent loan with a USDA lender:

1. Apply and get preapproved by a mortgage provider that offers USDA single-close construction loans.

2. Find an appropriate property that is located within a USDA-approved rural area.

3. Choose an experienced builder that meets USDA contractor requirements.

4. Have your certified site and home plans approved by your lender.

5. Wait for your mortgage company to fully underwrite and approve your loan.

6. Close on your USDA construction loan, paying any closing expenses not wrapped in.

7. Begin paying interest-only payments on your mortgage, or include these costs in your final loan balance.

8. Keep in contact with your lender and builder to ensure work is beginning and the appropriate draws have been released.

9. Follow up on the progress of your build throughout the construction process.

10. Have a final inspection completed and obtain a certificate of occupancy for your home.

11. At this point, your single-close mortgage automatically converts into a permanent 30-year loan.

12. Move into your new home and begin making your monthly mortgage payments.

Costs and Fees to Consider

Even though the USDA new construction loan program offers 100% financing for the purchase of land and construction of your home, there are some associated costs and fees worth considering before moving forward:

• Closing Costs: All mortgages have closing costs, which are the fees and expenses related to issuing a loan and transferring property. With a USDA loan, plan on costs running between 3% and 5% of your total mortgage balance.

• USDA Guarantee Fees: The USDA charges an upfront guarantee fee of 1%, generally considered as part of the USDA closing costs. However, you'll also be responsible for an ongoing annual fee of 0.35% of your loan balance, divided equally among your monthly payments.

• Interest-Only Mortgage Payments: You must make interest-only payments on your loan throughout construction. However, you may be able to wrap these costs into your total balance and begin with your full payments once construction is complete and the loan converts into a permanent mortgage.

• Property Taxes and Insurance Escrows: You'll be responsible for funding escrow accounts for property taxes and insurance costs incurred following closing.

Why Is It Difficult to Find a Lender?

One of the most challenging aspects of taking out a USDA construction loan is finding a mortgage company participating in the program in your area.

Few USDA lenders currently offer construction loans, so your best shot at getting approved may be to seek a lender specializing in new home construction.

Some reasons it’s so difficult to find a USDA construction lender include:

• USDA guidelines require lenders to have two years of experience overseeing construction loans or to hire an outside agency with suitable experience.

• Construction loans are more complex than purchase loans, requiring far greater human oversight and countless additional work hours.

• There’s more risk and liability associated with a new build compared to making a loan for an existing home.

• Most lenders don’t get enough USDA construction loan applications to make it worthwhile.

• Mortgage companies earn greater profits on simple purchase and refinance transactions.

What About Other Construction Loans?

USDA construction loans may be challenging to come by, but what about other types of construction mortgages?

VA construction loans are also notoriously hard to get. While the terms may be more favorable for eligible buyers, you're unlikely to find the homebuilding process any easier with the VA than with the USDA.

FHA one-time construction loans are more common but still often more challenging to get approved than conventional or double-close mortgages.

Borrowers who qualify for a conventional construction loan are more likely to find single-close lenders. Still, plan for at least a 5% down payment.

Traditional two-closing construction loans are the most straightforward option. Qualified borrowers should have little problem finding a lender to issue a loan to purchase land and finance the building of their home. However, this option will likely require a decent down payment and must be refinanced into a permanent mortgage when the property is move-in ready.

USDA Construction Loan Alternatives

Apart from the different types of construction-to-permanent loans, you may have some other alternatives to consider:

• USDA Purchase Loans – If the process feels overwhelming or you can't find a construction lender in your area, using a USDA loan to purchase an existing home may be a lower-stress solution.

• Rehab Renovation Loans – Offered through various programs, rehab renovation loans like the FHA 203(k) let you purchase an existing home and finance major improvements and renovations so that the property better fits your household’s needs.

• Traditional Construction Loans – Although the process adds extra costs and risks, it’s much easier for well-qualified borrowers to take out a traditional construction loan and refinance it into a permanent mortgage when needed.

• Built-Up Equity in Your Existing Home – If you currently own a property with considerable equity, you may be able to use a HELOC or cash-out refinance to generate the funds needed to build your new home.

• Private / Family Loans – If you have access to a private lender or family member willing to loan the funds to build your home, you can likely refinance the newly built property into a long-term mortgage to repay the note.

FAQs: USDA Construction Loans

Here are some other frequently asked questions about USDA construction loans and the process of buying land and building a home.

Can You Buy Land With a USDA Loan?

Yes, you can buy land with a USDA construction loan, but only if the purchase is part of your plan to build a permanent residence on the site. You cannot use a USDA loan for speculative land investments or to hold onto vacant property for future use.

I’m a General Contractor – Can I Build My Own Home With a USDA Construction Loan?

No – USDA guidelines are clear that owner-builders are not eligible for an agency-backed construction loan. This extends to general contractors who would otherwise meet the contractor-builder requirements. You can still use a USDA construction loan but must hire another builder to oversee the project.

Are USDA Construction Loans Available in Every State?

The USDA Rural Development construction loan is part of a nationwide program available in every state. However, only some USDA lenders participate in the program, and some locations may have few options regarding mortgage providers.

Is a USDA Construction Loan the Right Choice for You?

If you plan to build a home in a rural setting, a USDA construction loan may be the most affordable way to complete your project. With zero down payment required and flexible credit score eligibility, a wide range of applicants can qualify for a mortgage.

However, a USDA one-time construction loan involves meeting various program requirements, and it's getting harder to find lenders offering these types of mortgages. In many cases, opting for an FHA or conventional single-close loan may be simpler, although both options require a small down payment.

To determine if you qualify for a new home construction loan through the USDA or another mortgage program, check out today's interest rates and apply with an experienced provider lending within your community.