When considering a loan for a home purchase many borrowers automatically assume that a conventional or FHA loan is the right choice for them. Before seeing a lender it can pay to find out what other loans you may qualify for. In some cases loans are available on the basis of occupation, such as VA loans or HUD homes obtained through a program like the Officer Next Door program. In other instances the most important consideration might be where the home is located. If you are considering purchasing a home in a rural area it is worth looking into loans offered by the USDA Rural Development.
USDA Rural Development loans
The most important thing to remember with rural loans is that the house in question must be in a rural area. Don’t plan on buying a house in Houston for example with one of their loans, you need to look outside of the more heavily populated areas and towards some of the smaller towns. If you have questions about what is rural in your area contact your local USDA Rural Development office. You can find your local office by clicking on your state on the map here: http://www.rurdev.usda.gov/recd_map.html.
What Kind of Loan Do I Qualify For?
The biggest thing that will determine the type of loan that you are being considered for is your income. The USDA will compare your income to a number called the Area Median Income, or AMI. This number varies from county to county, another good reason to call the local USDA office. The AMI is also based on your family size. If your income is between 115% and 80% of the Area Median Income you will be considered for a USDA Guaranteed Loan. If you make less than 80% of the Area Median income you can be considered for a USDA 502 Direct loan.
The Guaranteed Loan
A guaranteed loan is basically a loan through a private lender, bank, credit union, that the USDA guarantees, or insures. The lender must be approved by the USDA, so ask around and let them know that you would like a guaranteed loan through the USDA. Why? Well, for one thing they don’t require a downpayment. That’s right, you can, if you must, borrow up to 100% of the value of the home. The loan can be used to buy, build, or even buy an existing home and make qualified repairs and upgrades. The loan is a standard 30 year term at the market rate. Just like qualifying for a regular loan they will check your employment and credit history. For more information on this program look at the USDA Rural Development website here: http://www.rurdev.usda.gov/HAD-Guaranteed_Housing_Loans.html, or call your local office.
The 502 Direct Loan
The USDA 502 Direct loan, I will just call it a 502 loan for short, is different from a guaranteed loan in many ways. For one thing with a 502 Loan your lender is the UDSA. That’s right, you are borrowing directly from the government.
Benefits of the 502 Loan
This loan is a totally different animal from most loans that your are used to. For one thing, remember that bit about borrowing directly from the USDA? Well, that also means they handle the loan closings as well, and the closing costs are much less than what you will pay for a normal loan. The second thing to is that just like the Direct Loan the 502 loan does not require a down payment. The third thing is that the payments on this loan are subsidized based on your income. This means if the loan usually has a 5% interest rate the borrower will pay part of the interest, and the USDA will subsidize, or pay the rest. How much you pay depends on your income, but is usually around 24% of what you make in a month. The subsidy cannot reduce the loan payments below 1% interest, so need to be able to afford the principal payment, plus 1% interest, and taxes and insurance on the property. The loan term is 33 years, though in some cases this can be extended out to 38 years. Like the Guaranteed loan the 502 Loan can be used to purchase an existing home or to finance new construction.
Qualifying for the 502 Loan
We already mentioned that you need to meet the income requirements for the loan, meaning you need to earn less than 80% of the Area Median Income as we pointed out before. The USDA will pull your credit history to qualify you for the loan. If you have unpaid collections or judgments those will need to be resolved to qualify. They will also look at your debt ratios, they want to make sure you can actually afford the loan.
This program is designed to provide affordable housing, not finance your Rural Castle. The USDA will inspect the home to make sure it meets certain building quality specifications. They will also consider if the home is modest in cost, size, and construction quality.
Your income will be reviewed annually. As your income goes up, your payment will can be adjusted as well. Once you are paying more than 1% of the loan the payment is based on a very simple equation. You will pay 24% of your monthly income.
The last thing to point out is that this loan has a repayment requirement. When you sell the house you may be asked to repay some of the subsidy that was paid on your behalf. How much you repay depends on how much subsidy you have received and on if the home has appreciated in value. This is actually a feature of the loan that I like. You never repay more than what they helped subsidize and the USDA does not charge any interest on the subsidy funds they used on your behalf. Basically you had an interest free loan to help make your house payments that you may repay when you sell the house.
For more information give your local office a call or visit the USDA website at http://www.rurdev.usda.gov/HAD-Direct_Housing_Loans.html.
I really like the USDA loans, the 502 loan in particular. The way they handle the payment schedule helps keep the loan affordable and encourages the borrower to keep increasing their income. The repayment of subsidy when the home is sold helps keep the program funded and is fair to the taxpayers who ultimately fund the program. It’s no free lunch, yet truly opens the door for low income home buyers in rural areas and gives them the opportunity to purchase a home and gain equity.
So, if you are considering purchasing in a rural area, give your local USDA Rural Development office a call and see what options are available to you.