What is a USDA Loan?
USDA loans are special mortgages meant for low- to moderate-income home buyers. These loans are guaranteed by the US Department of Agriculture. That guarantee acts as a form of insurance protecting USDA mortgage lenders, so they’re able to offer below-market interest rates and zero-down home loans. USDA runs this program to encourage homeownership and economic development in rural areas.
How Does a USDA Loan Work?
Using a USDA loan, buyers can finance 100% of a home’s purchase price while getting access to better-than-average mortgage rates. This is because USDA mortgage rates are discounted as compared to rates with other low-downpayment loans. Beyond that, USDA loans aren’t all that “strange.” The repayment schedule doesn’t feature a “balloon” or anything non-standard; the closing costs are ordinary; and, prepayment penalties never apply. The two areas where USDA loans are different is with respect to loan type and downpayment amount. With a USDA loan, you don’t have to make a downpayment; and you’re required to take a fixed rate loan. ARMs are not available via the USDA rural loan program. Rural loans can be used by first-time buyers and repeat home buyers alike. Homeowner counseling is not required to use the USDA program.
USDA Loans Require Mortgage Insurance (MI)
USDA “guarantees” its loan program — meaning it offers protection to mortgage lenders in case USDA borrowers default. But the program is partially self-funded. So to keep it running, the USDA uses homeowner-paid mortgage insurance premiums. As of October 1, 2016, USDA has lowered its mortgage insurance costs for both the upfront and monthly fees. As a real-life example: A homebuyer with a $100,000 loan size in Blacksburg, Virginia, would be required to make a $1,000 upfront mortgage insurance premium payment at closing, plus a monthly $29.17 payment for mortgage insurance. USDA upfront mortgage insurance is not paid as cash. It’s added to your loan balance for you.
USDA mortgage insurance rates are lower than those for comparable FHA loans or conventional ones. With USDA loans, then, mortgage insurance premiums are just a fraction of what you’d typically pay. Even better, USDA mortgage rates are low. USDA mortgage rates are often the lowest among FHA mortgage rates, VA mortgage rates, and conventional loan mortgage rates — especially when buyers are making a small or minimum downpayment. For a buyer with average credit scores, USDA mortgage rates can be 100 basis points (1.00%) or more below the rates of a comparable conventional loan. Lower rates mean lower payments, which is why USDA loans can be extremely affordable.