USDA Renovation Loans: Purchase a Home and Fund Improvements

Waiting for the right property to hit the market can take years.

Fortunately, there is an alternative for rural buyers: the USDA renovation loan can help you purchase a home and then use the lender's funds to update the property so it better suits your needs.

Often referred to as home improvement or rehab loans, the USDA renovation mortgage program can help expand your homebuying options while allowing you to finance up to 100% of your purchase and repairs.

Key Takeaways

• USDA renovation loans let you purchase a home and complete eligible repairs and improvements with a single mortgage.

• The USDA offers a limited renovation loan for non-structural repairs up to $35,000, and a standard renovation loan for structural changes and more costly improvements.

• Only single-family primary residences in agency-approved rural areas are eligible for a USDA rehab loan.

• USDA loans require no down payment – even for home improvement mortgages. In some situations, you may also be able to wrap closing costs into your loan.

• USDA renovation lenders might be hard to find

• Conventional renovation loans have fewer restrictions than the USDA program but require a minimum of 3% down.

What Is a USDA Renovation Loan?

A USDA renovation loan is a type of mortgage from the United States Department of Agriculture that allows you to purchase and renovate residential properties in eligible rural areas.

Unlike standard mortgages, which help with the cost of buying a home, USDA home improvement loans also provide funds for things like:

• Replacing a roof

• Adding a bedroom or bathroom

• Remodeling a kitchen

• Removing safety hazards

• Making accessibility improvements

These loans can help you bring the property up to USDA’s minimum property requirements at closing, the USDA rehab mortgage lets you purchase a fixer-upper and make the necessary improvements or modernizations before moving in.

The USDA Rehab Loan Process: Step-by-Step

What exactly does the USDA rehab loan process entail? Here’s a quick step-by-step guide to what you can plan to expect when applying for a home improvement mortgage.

1. Find a Lender and Get Preapproved

The first step is to find a USDA lender who offers renovation loans in your area and go through their preapproval process. The USDA renovation loan program is a niche product, and not all mortgage companies may offer it. As such, it can be more challenging to find a lender in some areas than others.

2. Select an Eligible Home and Get It Under Contract

Once you’ve been preapproved and have a healthy idea of your homebuying and repair budget, the next step is to find a fixer-upper home located in an approved rural area and get it under contract.

3. Obtain Cost Estimates for Qualified Contractors

After you have a property picked out and locked under contract, you will need to find a contractor that meets the USDA's requirements of two years of experience, proper licensing, and appropriate general liability insurance and have them complete a cost estimate for your proposed renovations.

4. Submit Contractor Estimates to Your Lender

Your lender will then review your contractor's cost estimates and compare them to the terms of the loan you're applying for. Remember that the limited renovation loan is restricted to non-structural repairs under $35,000.

5. Provide All Required Documents and Wait for Lender Underwriting

Your lender receives and reviews your contractor’s estimate. Wait while the lender completes the underwriting of your loan. Make sure to stay on top of any requested documents to ensure the process moves forward with minimal delay.

6. Close on Your New Home

When your mortgage company gives the go-ahead, the transaction can move to the closing stage. This generally involves meeting with your title company, settlement service, or real estate attorney to go over and sign all of the closing documents. Closing costs not wrapped into your loan or otherwise accounted for must be paid at this time, and after everything is said and done, you’ll receive the keys to your new home.

If your property is habitable, you can move in now. If work is needed to raise it to living standards, you can finance up to six months of mortgage payments into your new loan.

7. Begin Repairs on the Property

After closing, your mortgage provider or loan servicer will work alongside your contractor or builder to ensure that construction has begun and is being completed on schedule. Your loan administrator will handle the disbursement of funds for materials and work completed, with improvements expected to be finished within six months.

8. Compete Repairs and Have the Work Inspected

Once the work has been completed, your lender will arrange a final inspection to ensure that improvements were done appropriately and in line with the project plans. If all is good, your home will be cleared for occupancy (if you are not already occupying it), and you can move in and begin enjoying your newly improved property.

Use One Loan for Purchase and Repairs

With a USDA rehab mortgage, you can use a single loan to purchase your home and make repairs and improvements. The entire process is financed by your lender, meaning you won't have to come out of pocket to renovate your new home.

Once you close on your loan, your USDA-approved builder or contractor will begin working while your loan servicer pays out funds as project milestones are reached.

If the home is habitable, you can move in while work is completed. If not, you can finance up to six months of mortgage costs, meaning you won't be on the hook for your monthly payments until you can occupy the property.

Limited vs Standard USDA Home Improvement Loans

The USDA offers two different renovation loan options:

The limited USDA renovation loan allows buyers to make up to $35,000 in non-structural improvements to their new home.

This could be things like:

• Remodeling a kitchen

• Updating flooring

• Replacing windows and doors

• Making minor roof repairs

The standard USDA renovation loan can be used when structural improvements are needed, or total costs exceed $35,000.

Some acceptable projects under the standard renovation loan include:

• Adding a bedroom or bathroom

• Fully replacing a roof

• Fixing structural deficiencies

• Remodeling a home for handicapped accessibility

Pros and Cons of the USDA Renovation Loan

The USDA home improvement loan program offers homebuyers several advantages over other types of mortgages, but there are also some potential disadvantages.

Pros of the USDA Renovation Loan

A few of the most commonly cited pros of the USDA renovation loan include:

Zero Down Payment

With a USDA rehab loan, you can purchase a fixer-upper home and finance all the repairs and improvements without using your own funds. If your “as completed” value is estimated to be higher than the amount you plan to borrow, your lender may even let you wrap in some or all of your closing costs.

By comparison, FHA home improvement loans require you to put 3.5% down, while conventional rehab mortgages require 3% or more depending on the buyer and type of property.

No Private Mortgage Insurance

Conventional lenders require all borrowers with less than 20% home equity to carry risk-based private mortgage insurance (PMI). While it's possible to pay $100 or less per month in PMI, most borrowers – especially those with lower credit scores – will pay more.

The USDA does not require private mortgage insurance, but it does charge an “annual fee.” This is equal to 0.35% of the loan amount paid in monthly installments with your mortgage payment. Despite the fee, you’ll likely have cheaper monthly payments than on a conventional loan.

Cons of the USDA Renovation Loan

USDA loans aren’t without a few potential cons, although these may not be problems for every buyer.

Rural Area Requirements

All USDA loans – including home improvement mortgages – are limited to USDA-approved rural areas. Communities must typically have a population of 35,000 or fewer to qualify. However, an estimated 97% of the US landmass is within eligible boundaries.

In contrast, renovation loans issued by the FHA, VA, or conventional lenders do not have any geographic restrictions.

Household Income Limits

USDA applicants must meet household income limits for their area, typically set at 115% of median household income.

In most areas of the country, the income limit for a household of four in 2024 is $112,450. Keep in mind, however, that this limit applies to all members of the household and not just mortgage applicants.

No other major renovation loan programs require buyers to meet income restrictions.

Single-Family Homes Only

You can only use a USDA renovation loan to purchase and fix up single-family homes. You cannot purchase a multifamily residence, although homes with accessory dwelling units may be acceptable in some scenarios. You may also not use a rehab loan to buy and repair a manufactured home or condo.

Conventional renovation loans have fewer property-type restrictions. You can use them for multi-unit primary residences, second homes, and single-unit investment properties.

Requirements and Eligibility for USDA Home Improvement Loans

The requirements and eligibility for USDA home improvement loans are largely the same as for other USDA-backed mortgages. However, there are some added restrictions unique to the rehab program that borrowers must also abide by.

Who Is Eligible for a USDA Renovation Loan?

USDA borrower eligibility requirements are primarily focused on ensuring applicants can afford their loan, are likely to make consistent on-time payments, and fit within the USDA's mission to serve low- to moderate-income homebuyers.

Credit Score

The USDA does not set a credit score minimum for its rural development loan program. Instead, mortgage lenders are given the liberty to assess loans individually and establish their own appropriate credit score requirements.

USDA lenders often look for a credit score of at least 640. However, many lenders are willing to accept lower scores – even into the 500s.

Remember, though, that lenders may have higher criteria for USDA renovation mortgages than the standard loan.

Debt-to-Income Ratio

Your debt-to-income (DTI) ratio measures how your monthly debt stacks up against your qualifying income.

Lenders look at two different debt ratios: your housing DTI and total DTI.

USDA loans generally require you to spend no more than 34% of your gross income on the full house payment including principal, interest, taxes, insurance, and HOA dues. Your total DTI including all other debt payments can be up to 41% or 44% with compensating factors.

Household Income Limits

For most areas, the 2024 income limit for a household of four is $112,450 including all members of the household including those not on the loan. This limit increases in high-cost areas. The USDA's income limits list will show the current maximums for your area.

What Properties Are Eligible?

Properties must be located within an approved rural area to be eligible for a USDA mortgage – including the USDA home improvement loan program. This designation is typically restricted to communities with fewer than 35,000 residents. You can use the USDA eligibility map to determine if a home you're considering qualifies for an agency-backed mortgage.

Other property-based criteria include:

• Homes should be considered modest, generally interpreted as having no more than 2,000 square feet of living area.

• Only single-family residences are eligible for USDA-backed loans. You cannot purchase a multifamily home, although properties with an accessory dwelling unit (ADU) may be acceptable if the ADU is not used to generate rental income.

• You must plan to live in the home as your primary residence. You can't use the USDA loan program to purchase vacation property such as a lake house or mountain cabin, nor can you use it for investment purposes.

Extra Requirements for Rehab Loans

• The property you’re renovating must have been built and approved for occupancy at least 12 months prior to closing. You cannot use a USDA rehab loan on new or unfinished construction homes.

• Builders and general contractors must have at least two years of experience in all aspects of home improvement needed for the job.

• Those doing the work must also be appropriately licensed in accordance with local regulations and carry commercial general liability insurance with at least $500,000 of coverage.

• The property must already be classified as a single-family residence. You cannot use a USDA home improvement loan to convert another structure – such as a barn or rural schoolhouse – into a private residence.

• You can use a USDA renovation loan to tear down and rebuild, but you must use the existing foundation.

• Condos and manufactured homes, which generally qualify for USDA mortgages, are excluded from the rehab loan program.

What Kind of Renovations Can You Do?

You can use a USDA rehab loan to purchase a home and make all sorts of renovations and improvements. Some of the most common loan uses include:

• Remedying health and safety hazards

• Making structural or foundational repairs

• Accessibility improvements to accommodate disabilities

• Repairing or replacing roof and siding

• Adding bedrooms or bathrooms

• Renovating outdated kitchens and bathrooms

• Updating plumbing systems

• Updating electrical systems

• Upgrading HVAC systems

• Adding or repairing a well or septic system

• Replacing windows and doors

• Replacing carpet or other flooring

• Painting the interior or exterior of the home

• Adding insulation

• Weatherizing the home

• Making energy-efficient upgrades

• Repairing existing swimming pools, hot tubs, and saunas

Ineligible Home Repairs

The USDA does prohibit the renovation loan program from being used to make certain repairs and improvements. Some of the ineligible home modifications include:

• Repairs to condos and manufactured homes

• Converting other types of properties – such as an old schoolhouse or church – into single-family residences

• Improvements designed to be income-producing

• The installation of new inground pools, hot tubs, and saunas

• Other new installations considered to be luxury improvements, such as an outdoor kitchen or fireplace

How Do Eligible Repairs Compare to Other Home Improvement Loans?

The USDA is not the only renovation loan program available to homebuyers. Borrowers can also purchase and rehab a home with conventional, FHA, and VA mortgages. How do these programs' allowances and restrictions compare to the USDA renovation loan?

VA Renovation Loans: Improvements are generally more limited with the VA than the USDA. VA guidelines allow for minor renovations, which can be completed within 120 days of closing. You cannot use a VA renovation loan to make significant structural changes or improvements.

FHA Renovation Loans: The FHA 203(k) renovation loan program has restrictions similar to the USDA. Likewise, the FHA offers two rehab programs: the Limited 203(k) for minor non-structural repairs and the Standard 203(k) for more extensive improvements.

Conventional Renovation Loans: Conventional rehab options like the Fannie Mae HomeStyle Renovation and Freddie Mac CHOICERenovation mortgages offer far more flexibility than the USDA or other government-backed programs. You can use a conventional renovation loan for just about any improvement or modification you want, and loans are not limited to single-family primary residences. You can use a conventional home improvement loan on properties with up to four units, second homes, and some investments and rentals.

How Much Can You Borrow?

Rehab loans focus on “as completed” value – the amount the home will be worth once all proposed renovations are complete.

The USDA rehab loan program allows you to borrow up to 101% of this estimated future value, including the 1% USDA upfront guarantee fee.

For example, suppose you're purchasing a home for $175,000 and plan to make improvements that will bring the value up to $250,000. In that case, you can use the $75,000 difference – minus contingency reserves, allocated PITI payments, and applicable inspection/consultant fees – to complete your renovations.

Remember that you still need to have the income to qualify for the loan size you're applying for. If your lender can only approve you for a $225,000 mortgage, your improvements would be limited to $50,000 less deductions.

Contingency Funds

The USDA requires that you have a contingency fund in place to protect against overruns, such as increases in material costs or unplanned work necessary for project completion.

You do not need to put up your own money for the renovation loan contingency – funds are set aside from the amount allocated for improvements. The amount required depends on whether utilities are on or off at the property.

• When utilities are connected and working, you must have a reserve fund equal to 10% of the planned project expenses.

• When utilities are not connected or functional, all USDA renovation loans must have a 15% reserve fund.

The rationale is simple: it's much easier to accurately evaluate the condition of a home and its systems when utilities are functional. Some issues are less likely to be noticed without utility service until construction is underway.

Other Programs’ Contingency Fund Requirements

How does this compare to other renovation loan programs’ contingency reserve requirements?

Fannie Mae’s HomeStyle Renovation program does not require a contingency reserve for single-unit properties. Homes with two to four residences require a 10% contingency fund.

Freddie Mac’s CHOICERenovation loan rules are similar to USDA's: properties with functional utilities require a 10% reserve, while those without working utilities need 15%.

The FHA 203(k) contingency requirement varies based on the age and condition of the home. Residences under 30 years old without termite damage do not typically need a contingency fund. If termite damage is present, a 10% fund is required. Structures 30 years or older follow the USDA's lead in requiring 10% if utilities are connected and 15% if not.

VA renovation loans do not usually require a contingency fund except when the lender determines it is necessary.

USDA Rehab Loans vs Other Renovation Mortgages

We’ve briefly reviewed a few of the other renovation mortgage options and how they compare to USDA home improvement loans. Let’s take another look at these rehab loan alternatives and whether they may be a better fit for your residential purchase and renovation needs.

Conventional Renovation Loans

Conventional renovation loans include the HomeStyle Renovation and CHOICERenovation mortgages. Borrowers will need a minimum credit score of at least 620 to qualify for these programs, with a total DTI no higher than 50%, but expect lower DTIs for renovation loans. Conventional loans do not have maximum income limits, except for programs like HomeReady and Home Possible, which are aimed at lower-earning buyers.

There are fewer limits to the improvements you can make with a conventional rehab loan, and you aren't limited to single-family primary residences. Multi-unit primary residences, second homes, and single-unit investment properties are all eligible. Plus, you aren’t restricted to USDA-approved rural areas.

Depending on the buyer and type of property, a conventional renovation loan can finance up to 97% of the future “as completed” value.

FHA Renovation Loans

The FHA 203(k) renovation loan program allows you to borrow up to 96.5% of a home's future “as completed” value without the USDA renovation program's income limits or geographic restrictions.

You’ll typically need a minimum credit score of 580 to 640, depending on the lender, to qualify for an FHA 203(k), meaning it may be easier for lower-credit applicants to get approved.

However, FHA loans have higher fees than USDA loans. All FHA-backed mortgages require a 1.75% upfront mortgage insurance premium and an annual MIP of 0.55% for most borrowers.

VA Renovation Loans

With a VA renovation mortgage, you can purchase a home and wrap minor, non-structural improvements into your loan. Like the USDA, VA loans let you finance the entire cost of buying and rehabbing the home. In most cases, you will not need to put any money down.

However, VA loans are only available to borrowers with eligible military service.

The agency sets no required credit score or maximum DTI ratio, instead leaving discretion up to individual VA lenders. Generally speaking, you should aim for a credit score of 580 to 620 and a DTI of around 40% to qualify for a VA renovation loan.

Risks and Rewards With Rehab Loans

USDA rehab loans are an excellent way for rural homebuyers to purchase and renovate a property to fit their needs. While there can be risks with the process – including cost overruns and project management challenges – the program also has the opportunity for rewards.

In some cases, buyers can make improvements that increase their new home's value beyond the cost they paid. Plus, properties requiring renovations often create an opportunity for buyers to negotiate more favorable terms, including potential seller concessions.

To determine if you're eligible for a home improvement mortgage through the USDA or other rehab programs, check out today's current interest rates and apply with a lender in your homebuying area.