There are many myths that surround the USDA Guaranteed Loan, one of which is that you must be a low-income borrower. In reality, you can make as much as 115% of the average income for your area and still qualify. In many areas, this means $78,200. However, it can mean as much as $202,250 in some areas.
The USDA breaks income categories down into three categories:
- Very low income
- Low income
- Moderate income
The borrowers in the moderate income category qualify for the guaranteed loan. Borrowers in the very low or low income often qualify for a USDA Direct Loan, which has different qualifications, fees, and terms.
How the USDA Determines Income and Low-Income
The USDA looks at income differently than any other program. First, they determine your eligibility for the program. This is not your qualification for it. You must prove you have a need for the program as it is for those that cannot secure financing with any other program.
The USDA uses the income of all adults in the household to determine your eligibility. For example, if you live alone, it’s a simple calculation. You know your gross monthly income and that’s what you use to qualify for the loan.
If you live with one other person, both incomes are used to determine your total household income. Now let’s say you live with your spouse, and your two parents. If your two parents have income, the USDA will include their income in the calculation as well. They do so because they recognize that extended families often contribute to monthly bills. If your total household income is too high, you will not qualify for the program.
However, there are allowances or deductions you may be able to get if you have people other than yourself living with you:
- You can receive an allowance of $480 per child under the age of 18 that lives with you full-time
- You can receive an allowance of $480 per child over the age of 18 that lives with you if they are a student
- You can receive an allowance of $480 per disabled person that lives with you
- You can receive an allowance of $400 per elderly person that lives with
The allowances hope you take into account the cost of caring for children, the disabled, and the elderly.
You can determine your eligibility income and see if you are eligible for the program by using the USDA’s income eligibility tool.
Qualifying for the USDA Loan
Once you know you are eligible for the program, you still have to qualify for it. This is where it gets tricky. That income you used from above to prove eligibility doesn’t matter. Only the borrower and co-borrower’s income can be used for qualification purposes.
In order to qualify for the USDA loan, you must meet the following requirements:
- Minimum 620 credit score (the lender will use the lowest credit score between the two borrowers)
- You must buy or refinance a home that is in a rural area (a large majority of the US is in a rural area according to the USDA though)
- Front-end housing ratio no higher than 29% (no more than 29% of your gross monthly income can cover the proposed mortgage payment)
- Back-end ratio no higher than 41% (this includes the proposed mortgage payment plus any existing debts)
If you meet the above requirements, you may be eligible to secure 100% financing for your modest home. However, the property must meet the USDA’s minimum requirements.
The home must be safe, sanitary, and structurally sound. In addition, it must be modest in design and cost for the area. Lastly, it must meet all local city and/or county codes. Again, the home must be modest – if it has a pool, it will likely not qualify for USDA financing.
In reality, USDA loans are not for low-income borrowers. It’s actually a program for modest income borrowers, but they cannot be eligible for any other financing. This includes FHA, VA, and conventional loans. It’s for borrowers that have less than perfect credit and moderate income.
If you do qualify for the USDA loan, you will pay a funding fee of 1.0% of the loan amount at the closing. This helps fund the USDA’s ability to continue to guarantee loans for lenders. Because USDA loans are for ‘risky’ borrowers, the USDA guarantees the loans so that lenders can lend to risky borrowers without feeling as if they are putting their neck on the line. If a borrower defaults, the USDA pays the bank back a portion of the lost funds.
In addition to the funding fee, you’ll also pay a small annual mortgage insurance fee of 0.35% of the outstanding principal balance. On a $100,000 loan, this means $29 a month. This is just a fraction of the mortgage insurance the FHA charges borrowers.
If you are a moderate income family and will purchase a home in a rural area, the USDA loan is a great option. If you are a low-income family, you may want to consider the USDA Direct Loan, which offers even more support for families with little income.