The Huge Benefits of a USDA Loan, Plus Some Drawbacks

The USDA loan program aims to make homeownership affordable for low- and medium-income borrowers looking to buy in low-density rural communities. In many cases, a USDA-backed loan will offer lower monthly payments than other types of available mortgages – especially for borrowers with less-than-stellar credit who may not qualify for the best conventional rates.

If you're considering applying for a USDA loan, read on. We'll take an in-depth look at the biggest USDA loan benefits and touch on a few of the disadvantages that you should be aware of as well.

Key Takeaways

• USDA loans are a no-down-payment mortgage option for buyers purchasing a home in eligible rural areas.

• USDA interest rates are often lower than conventional mortgages, and borrowers are not required to pay for private mortgage insurance.

• Refinancing a USDA loan is simple thanks to the agency’s low-doc streamline refinance option that doesn’t require a new appraisal, detailed credit check, or income verification in most cases.

• Despite a 1% upfront guarantee and ongoing 0.35% annual fee, USDA loans are often the most affordable option for eligible borrowers.

Pros and Cons of USDA loans

Before we take a deep dive into the benefits of USDA loans (and a few of the negatives), let's start by highlighting the most impactful pros and cons of this government-backed mortgage program.

USDA Loan Benefits and Advantages

The USDA loan program allows borrowers to purchase eligible rural properties with no money down, low interest rates, and freedom from costly private mortgage insurance. Even when accounting for the upfront guarantee and annual fee, USDA-insured mortgages are frequently the most affordable option for qualifying borrowers.

No Down Payment Required

Buyers are often drawn to USDA loans because the program allows them to purchase a home with 0% down. This provides the flexibility to shop for a property without having to save up thousands of dollars to put towards the purchase.

That's not to say that you can't make a down payment with a USDA loan – you can if you choose to – but it isn't required.

With most other types of loans, borrowers would need a down payment between 3% and 5% of their purchase price. On a $250,000 property, that could mean having to come up with anywhere from $7,500 to $12,500 to put down.

Competitive Interest Rates

Most USDA loans are issued by banks or private lenders and backed by the United States Department of Agriculture. Because the USDA insures the mortgages and provides protection in the event of default, applicants are often able to qualify for interest rates below conventional norms. This is particularly true for borrowers with lower credit scores.

Homebuyers who earn no more than 80% of their area’s median income may even be eligible for a loan directly from the USDA with a subsidized interest rate that’s even lower.

Flexible Credit Score Requirements

While most loan programs set firm credit requirements, the USDA does not have a fixed minimum score.

Instead, individual lenders are given the flexibility to set their own requirements. While many companies look for a score of at least 640 – the minimum required to use the USDA's automated underwriting platform – some mortgage providers are willing to lend to a broader range of borrowers.

In many cases, it’s possible to find a USDA lender willing to accept credit scores well into the 500s from applicants who are otherwise qualified to buy.

What if you don't have a credit score or don't have enough credit history to have established an accurate score? That's no problem – the USDA allows buyers to qualify on non-traditional credit based on their past rental payments and other alternative tradelines.

No Private Mortgage Insurance

Conventional borrowers with less than 20% home equity are required to pay for private mortgage insurance. This differs from your ordinary home insurance policy in that it protects your lender if you quit making payments on your loan. With a USDA loan, you do not need to carry private mortgage insurance.

Private mortgage insurance is risk-based, meaning borrowers with lower credit scores and less equity will pay higher rates. For many homebuyers, this can be costly.

For example, a conventional buyer with a credit score of 650 putting 3% down could be on the hook for an annual PMI rate of 1.54% of their mortgage balance, according to insurance provider MGIC. On a $250,000 loan, this would add $321 to their monthly mortgage payments.

Closing Cost Assistance & Rolling Closing Costs Into Your Loan

Since one of the primary USDA loan benefits is that they don't require a down payment, buyers are sometimes confused to learn that they may be responsible for paying closing costs. These are the expenses related to purchasing property and obtaining a mortgage and can range between 3% and 5% for most USDA borrowers.

Thankfully, you have a variety of options for how you cover these costs:

• USDA Down Payment Assistance – Down payment assistance (DPA) programs are offered across the country by government agencies and localized non-profits. Even though USDA loans do not require a down payment, borrowers who qualify for DPA can use the funds to cover their closing costs with most programs.

• Seller-Paid Closing Costs – The USDA allows sellers (and other interested parties such as real estate agents and lenders) to contribute up to 6% of a property's purchase price as concessions, which buyers can use to pay down their closing costs.

• Wrap Closing Costs Into the Loan – If your home appraisal comes in above your purchase price, you may be able to wrap some or all of your closing costs into your new loan. Even if your home appraises for exactly the amount you offered, the USDA will still allow you to roll in the 1% upfront guarantee fee.

No Cash Reserves Required

Some types of mortgages require homebuyers to have enough funds in reserve after closing to cover their total housing expenses for a fixed number of months. For example, if your total costs equal $2,000 per month, a lender requiring three months of reserves would want to see $6,000 available after deducing the cash needed for closing.

The USDA does not set any reserve requirements for its loan program. However, having additional cash can help improve your chances of being approved for a loan and may even result in slightly lower interest rates. In many cases, you can count up to 60% of a vested 401(k) or IRA toward your cash reserves, says USDA.

No Penalty for Paying Your Mortgage Off Early

Certain mortgages may charge you a penalty for selling your home, refinancing, or otherwise paying off your loan early.

USDA-guaranteed loans do not have a prepayment penalty under any circumstances. This means you could take out a loan and decide to refinance eight months later without being on the hook for any additional prepayment fee.

Streamline Refinance Option

Another of the top USDA loan benefits is that the agency offers one of the simplest ways for borrowers to refinance their mortgages: the USDA streamline refinance.

A streamline refinance is a low-doc loan that does not require a new appraisal, and in most cases, you won't need to undergo a detailed credit check or reverify your income, either.

This often results in a faster, cheaper, and less stressful refinance process. While some other government-backed mortgage programs offer their own streamline loans, there are currently no conventional streamline refinance options.

Potential Disadvantages of USDA Home Loans

Now that we've covered some of the biggest benefits of a USDA loan, it's only fair to point out some potential disadvantages of this type of government-backed mortgage.

Property Restrictions

This may actually count as one of the USDA loan benefits for some buyers, but program guidelines require all properties be located within approved rural areas. While cities and urban areas typically won’t qualify, many smaller towns and even some suburban communities may be eligible. You can use the USDA property lookup tool to see if the area you’re looking at qualifies.

In addition to locale, homes must also meet USDA appraisal requirements such as being structurally sound with a leak-free roof, and having mechanical systems that are functional and sufficient for the size of the house.

Modesty Requirements

The USDA also requires that properties be considered "modest," which it defines as a home “that a low- or moderate-income borrower can afford based on their repayment ability.”

As such, homes are generally restricted to 2,000 square feet or less, and properties with luxury additions or improvements may be denied funding. In the past, this rule even prohibited homes with swimming pools, although the USDA changed its guidelines in 2022 to allow inground pool properties.

Income Limits

Since the USDA mortgage program is designed for low- to medium-income buyers, all applicants must meet household income limits, which can vary based on the number of people living in the home and the area's median income. For most standard-cost regions in 2024, the limit is $112,450 per year for a household of four.

Maximum income amounts are adjusted annually. You can find the figures for your area on the USDA's current limit map.

Occupancy Requirements

USDA home loans are only available for your primary residence. You cannot purchase a vacation home or rental. Additionally, the property cannot be income-generating, such as a working farm or ranch.

You must also plan to move into your new home within 60 days of closing. The exception is if you're making repairs or renovations as part of a USDA home improvement loan. In this scenario, you have up to six months to complete work and occupy the property unless your lender grants an extension.

Upfront Guarantee and Annual Fees

While the USDA does not require mortgage insurance, all loans come with a 1% upfront guarantee and a 0.35% annual fee. You pay the annual fee monthly in 1/12 installments. a $250,000 loan would require a fee of $73 per month.

How do these costs compare to other types of loans? The FHA charges an upfront mortgage insurance premium of 1.75%, with most buyers paying an annual MIP of 0.55%. VA loans do not charge an ongoing annual fee, but the upfront funding cost is either 2.15% or 3.3% for the majority of borrowers.

Conversely, conventional mortgages do not have an upfront fee, but private mortgage insurance is obligatory for all homeowners with less than 20% equity.

The Process Can Take Longer Than Other Loans

USDA loans may take longer to process than other types of mortgages. One reason for this delay is that after your lender underwrites the loan, they must send the file to your local USDA office for secondary approval. This is generally completed in a timely manner but can sometimes add days or longer to the process.

Other delays can result from waiting for a property inspection, household income underwriting, and other USDA-specific requirements that lenders don’t need to worry about with different kinds of loans.

USDA Loan Alternatives

Still unsure if a USDA-backed mortgage is the correct type of loan for you? Here are some other alternative options that you may want to explore instead:

Conventional Loans

Conventional loans follow the guidelines established by Fannie Mae and Freddie Mac. A conventional mortgage typically has fewer limitations – you aren't restricted to rural areas, and there is no maximum household income. You can even use a conventional loan to purchase a multifamily residence, second home, or investment property.

Applicants should have a credit score of at least 620, although the best rates are generally reserved for scores of 740 and higher. First-time and lower-income homebuyers may be eligible for a 3% down payment – other borrowers should plan for 5%.

FHA Loans

FHA loans do not have the income or location restrictions that USDA-backed mortgages do. Borrowers are eligible for a 3.5% down loan with a credit score of 580 or higher. FHA interest rates also tend to be lower than conventional mortgages for most borrowers. However, all loans have a 1.75% upfront fee and an annual fee of 0.55% in most instances.

VA Loans

VA loans are available to qualifying servicemembers and honorably discharged veterans. Interest rates are usually among the lowest on the market, with no income or geographic restrictions. Plus, the VA also lets you borrow up to 100% of your home's value, meaning that you aren't required to have a down payment.

Most borrowers will pay a VA funding fee of 2.15% or 3.3% of their loan balance, though applicants with a service-related disability may qualify for a waiver.

Deciding If a USDA Loan Is Right for You

If you're planning to purchase a home in an eligible rural area, there's a good chance that a USDA-backed mortgage could offer an overall more affordable homebuying experience than most other types of loans. However, everyone's situation is unique, and despite all of the USDA loan benefits, some applicants may still find better value elsewhere.

To discover if a USDA loan is right for you – as well as what other mortgage options you may have available – take a look at the current interest rates and apply with an experienced lender today.