USDA loans are one of the few mortgage products that require zero down payment. And for those who qualify, that’s a huge advantage, freeing up cash for closing costs, moving expenses, new furniture, or even just a much-needed emergency fund.
Still, these mortgage aren’t right for every buyer. We break down the pros and cons of a USDA loan so you can figure out whether it’s right for you.
What's in this Article?
First, the good stuff
USDA loans are government-backed mortgages insured by the U.S. Department of Agriculture (USDA). They’re meant to help low- and moderate-income borrowers buy homes in qualifying locations, including rural and suburban areas throughout the country.
There are two types of USDA rural development loans: Guaranteed and Direct. The Direct loans are for very low- and low-income borrowers, and you have to apply directly through the USDA. The USDA Single-Family Guaranteed loans are offered through USDA-approved lenders, and those are what we’ll be referring to in this article.
Here are just a few of the major perks these mortgages offer prospective homeowners:
0% down payment requirement
This is perhaps the biggest benefit of a USDA home loan. Unlike most other mortgage loans, USDA mortgages require zero down payment. This can amount to huge savings up front.
An FHA loan, for example, requires at least 3.5% down. On a $200,000 home purchase, that’d be $7,000. Conventional buyers pay slightly less at 3% (still $6,000!). USDA borrowers can get into a home with no money down, which can shorten their homebuying timeline by years.
Lower mortgage insurance premiums
Mortgage insurance is a fact of life on low down payment loans.
Most FHA borrowers owe an upfront and ongoing mortgage insurance premium (MIP) for the life of their loans, and conventional loans require private mortgage insurance (PMI) until you reach 22% home equity.
VA loans don’t have a mortgage insurance requirement, but borrowers do pay a funding fee on the loan, calculated as a percentage of the purchase price.
USDA loans are no different in that they include an upfront Guarantee Fee and an annual mortgage insurance premium. But USDA mortgage insurance rates are lower than FHA loans, so if you’re eligible for both of these government programs, going with USDA could mean substantial savings on mortgage insurance.
See below for what you’d pay in mortgage insurance fees in the first year of a $200,000 fixed-rate 30-year loan:
|Mortgage Insurance Costs||USDA||FHA|
|Annual mortgage insurance rate||0.35%||0.85%|
|Total upfront and monthly MI in first year||$2,708||$5,228|
Note: The 0.85% premium is the most common fee paid by FHA borrowers, but exact rates vary based on the buyer’s down payment, loan amount, and repayment term.
As you can see, USDA mortgages can save you significantly up front, especially compared the most popular government loan program, FHA.
Competitive interest rates
Because the USDA mortgage program has the backing of the U.S. government, this reduces the risk for mortgage lenders, allowing them to offer low interest rates — even for borrowers with no down payment. A lower rate means a lower monthly payment and less paid in interest over the long run.
Gift funds and down payment assistance allowed
The USDA loan program allows you to use gift money or an assistance program to help cover your closing costs or down payment (if you wish to make one). A huge advantage to USDA over other programs is that you don’t have to take the extra step of finding, applying, and getting approved for down payment assistance unless you want to.
But many assistance programs are available, and come in the form of grants, which do not need to be repaid, or forgivable loans that you don’t need to repay if you stay in the home for a certain period of time.
Available for multiple property types
You can use a USDA loan to buy a number of different types of properties, including:
- Single-family home
- Land (if you’re building a new construction home)
- Manufactured home
USDA loans cannot, however, be used on investment properties or vacation homes.
Mult-unit properties are not eligible for USDA, even if you plan to live in one unit. If you’re in the market for a 2-4 unit home, consider FHA over USDA.
OK, now it’s time for the cons
Despite all of these pros, a USDA loan has its cons, too. Two of the biggest? The income limits you have to meet and the geographic restrictions they set on properties.
USDA loans are for low- and moderate-income borrowers only, so if you exceed the income limit for your area, you won’t be able to qualify.
If you were buying in Butler County, Alabama, for example, a four-person household would need to make $91,900 or less per year in order to qualify. In a costlier market like Los Angeles County, California, the limit is $138,000 annually.
You can use this list to determine the USDA income limits in your area. If you find that you’re above the limit by just a few thousand dollars, it’s still worth talking to a USDA lender about whether you meet the eligibility requirements.
USDA lenders calculate eligibility based on adjusted income, and you can use a number of deductions to try to stay within limits. For instance, you get a deduction for each child in your household, plus childcare expenses. So you may qualify even if your gross income appears to be somewhat out of range.
Geographic location requirements
A USDA loan can only be used to buy a home located in an eligible area. Despite the name, these loans are not just for rural areas. Many suburban areas qualify as well.
While USDA places caps on eligible city populations, towns and cities can also be eligible if they are “rural in nature.” This leaves a lot for interpretation, so it’s worth checking your area on the eligibility map.
Even around San Francisco, one of the most densely populated areas in the country, there are still many USDA-eligible areas. Everything not shaded in yellow on the below map is eligible. Working remotely? Only going to the office once per week? It might be worth living further out to take advantage of this program.
And here’s a look at Boston…
And a snapshot of Nashville…
Generally speaking, homes in urban and densely populated areas can’t be bought with USDA loans. Some exceptions apply, though, for places that have limited credit available for homebuyers, so it’s always worth checking before you buy.
You can use the USDA eligibility map search tool to see if a property you’re considering is in an eligible community.
Mortgage insurance for the life of the loan
USDA loans may have lower mortgage insurance premiums than other loan options, but you’ll also pay those premiums for life.
The only way to remove mortgage insurance is to refinance into a conventional mortgage, which requires at least 20 equity in your property.
You can only use USDA loans to buy a primary residence. If you’re looking to buy an investment property, second home, or vacation house, you’ll have to look at a conventional loan.
Additionally, properties must meet HUD’s minimum safety standards.
Longer underwriting times
For loans like FHA and VA, lenders have the authority to review and approve loans entirely on their own. USDA does not grant that ability to lenders.
The USDA itself reviews each loan file after the lender approves it. This could mean an additional week or two to close the loan compared to other loan programs.
So, should you get a USDA loan or not?
USDA loans have some major benefits — zero down payment being one of them — especially for first-time homebuyers.
Use this quick rule of thumb: If you’re buying in an eligible area and you’ve never served in the military, check out USDA first. Its zero-down-payment option and low mortgage insurance costs make it a clear winner over other programs.
But the best type of mortgage loan really depends on your unique circumstances, and some aspects of your file like income can make you ineligible anyway.
If you’re not sure one is right for your purchase, a lender can give you personalized guidance on your mortgage options.
USDA loan pros and cons FAQs
Not everyone — or every property — is eligible for a USDA loan, as there are strict income and location requirements. Additionally, USDA loans come with lifetime mortgage insurance premiums (MIP), although USDA’s MIP rates are lower than those for FHA loans.
A USDA loan can be a great choice for those who qualify. With no down payment requirement, these loans can free up funds you need for closing costs, moving expenses, and more. They can also allow you to buy a home sooner and with less in savings.
With a USDA loan, you’ll pay your annual mortgage insurance premium for the entire time you have the loan. The only way to remove the mortgage insurance requirement is to refinance into a conventional loan once you have enough home equity (20%).
USDA loans sound great. Where do I apply?
If a USDA loan sounds like a good fit after reviewing the pros and cons, you’ll want to get preapproved through a USDA lender.
USDA Guaranteed Rural Housing loans subject to USDA-specific requirements and applicable state income and property limits. Fairway is not affiliated with any government agencies. These materials are not from USDA or RD and were not approved by USDA or RD or any other government agency.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.