If you’re looking to invest in a rural property, the USDA loan can be an excellent option. It’s a zero-down financing program designed to promote homeownership in less densely populated areas.
But, you will likely be very limited in your ability to rent it out so this will largely be for appreciation and debt paydown which you can use to then start investing utilizing other real estate investing strategies.
Let’s explore how it works.
Eligibility/Requirements
USDA loans have specific eligibility requirements, especially related to location and income:
- Location Requirement – The property must be located in a USDA-approved rural area. You can use the USDA’s online map tool to determine if a property qualifies.
- Income Limits – Your household income must be below a certain threshold, which varies by location and family size. USDA loans are meant for low- to moderate-income borrowers.
- Credit Score – Most lenders require a minimum credit score of 640, but exceptions may be made for borrowers with lower scores if they can show a history of on-time payments.
Owner-Occupancy Requirement
USDA loans require that you occupy the home as your primary residence and have much stricter requirements for occupying the property:
- Owner-Occupancy Requirement – You must live in the home for at least one year before converting it to a rental, making USDA loans quasi-acceptable for Nomads™ who plan to start as owner-occupants. However, the USDA loan is more restrictive than other loan programs including significant limitations on who you can rent it to so be sure to follow their guidelines. For example, your rentals may need to be family.
Down Payment
One of the most attractive features of USDA loans is the no down payment option:
- No Down Payment – USDA loans offer 100% financing, so you can purchase a home with no money down. This makes it a great option if you’re looking to minimize upfront costs.
Loan-to-Value (LTV) Ratio
Here’s what you need to know about the LTV ratio for USDA loans:
- 100% LTV – USDA loans provide up to 100% financing, meaning the LTV ratio will be 100%, with no down payment required. You’ll only need to pay for closing costs unless the seller covers them by negotiating seller concessions from them when you make your offer to buy the property.
Interest Rates
USDA loans offer competitive interest rates:
- Fixed Interest Rates – Most USDA loans come with fixed interest rates, providing you with stable monthly payments. The rates are typically lower than conventional loans.
Amortization Period
USDA loans offer the following standard amortization periods:
- 30-Year Term – The most common term for USDA loans is 30 years, providing you with lower monthly payments spread over a longer period.
- 15-Year Option – A 15-year loan is available, but this option comes with higher monthly payments and therefore worse cash flow when you eventually convert it to a rental.
Private Mortgage Insurance (PMI)
While USDA loans don’t require PMI, they do have a similar fee structure:
- Annual Fee – Instead of traditional PMI, USDA loans come with an annual fee, which is currently 0.35% of the loan amount, paid in monthly installments.
- Upfront Guarantee Fee – USDA loans also require an upfront guarantee fee, which is 1% of the loan amount and can be rolled into the loan.
Loan Limits
USDA loans don’t have set loan limits like other government-backed loans:
- Income-Based Limits – The amount you can borrow is based on your ability to qualify for the loan given your income and the property’s appraised value. While there are no formal loan limits, the home’s price and your income must align with USDA guidelines.
Number of Loans Allowed
USDA loans have specific rules about owning other properties:
- One USDA Loan at a Time – You typically can’t own another property when applying for a USDA loan. It’s designed for those purchasing their first primary residence, not investment properties. You’ll need to fulfill the owner-occupancy obligations of the lender before moving out and converting the property to a rental and there are additional restrictions on renting out properties that have USDA loans making it more challenging.
Seller Concessions
USDA loans allow the seller to cover some of your closing costs:
- Up to 6% Seller Concessions – Sellers can contribute up to 6% of the purchase price toward your closing costs, helping to reduce your out-of-pocket expenses.
Waiting Period After Major Financial Events
USDA loans have fairly standard waiting periods after financial difficulties:
- Bankruptcy Waiting Period – You must wait three years after a Chapter 7 bankruptcy to apply for a USDA loan. If you’ve filed for Chapter 13, you can apply after 12 months of on-time payments with court approval.
- Foreclosure Waiting Period – After a foreclosure, you must wait three years to qualify for a USDA loan.
Refinancing Rules
USDA loans offer limited refinancing options:
- Streamline Refinance – USDA offers a streamlined refinance option, which allows you to refinance to a lower interest rate with reduced paperwork, as long as you’ve made 12 consecutive on-time payments.
- No Cash-Out Refinance – USDA loans do not allow cash-out refinancing, so you can’t take out equity from the property through a USDA loan refinance.
- Recast – You cannot typically recast a USDA loan.
Property Types Eligible
USDA loans are designed for specific types of properties:
- Single-Family Homes in Rural Areas – USDA loans are primarily for single-family homes in USDA-designated rural areas. Multi-family properties and vacation homes are not eligible.
Special Loan Features
USDA loans have a few unique features:
- No Down Payment Requirement – One of the biggest advantages is the 100% financing option, allowing you to purchase a home with no down payment.
- Low Mortgage Insurance Costs – The annual and upfront fees are generally lower than PMI for conventional and FHA loans, making USDA loans more affordable in the long run.
Approval and Underwriting Process
USDA loans have specific approval guidelines:
- More Lenient Income Requirements – USDA loans are aimed at low- to moderate-income borrowers, so the income requirements are more lenient compared to conventional loans.
- Rural Property Appraisal – The appraisal process may take longer because the property must meet USDA guidelines and be located in a qualifying rural area.
Risks and Considerations
There are a few important things to keep in mind with USDA loans:
- Location Restriction – The property must be in a USDA-approved rural area, which may limit your options if you’re investing in areas closer to urban centers.
- Income Limits – Your household income must meet the USDA’s guidelines, so this option is best suited for low- to moderate-income earners.
- Occupancy Limits – Because there are significant restrictions on who can occupy the property, USDA loans are not the first choice for most investors trying to utilize the Nomad™ or even house hacking strategy.