USDA Loan

A USDA loan is a home loan made or guaranteed by USDA Rural Development under the Housing Act of 1949, for a modest home in an eligible rural area, with the borrower's household income capped. The colloquial name hides a real distinction, and it is worth stating plainly because the two programs behave differently. The Single Family Housing Guaranteed Loan Program is set out at 7 CFR part 3555, which says it "addresses the requirements of section 502(h) of the Housing Act of 1949." Here an approved private lender makes the loan and USDA guarantees part of it, much as FHA insures and VA guarantees. The direct programs are set out separately at 7 CFR part 3550, which addresses "sections 502 and 504" of the same Act and is operated by the Rural Housing Service. Here the government itself is the lender.

Section 504 is a third thing again. The direct regulation describes it as offering "loans to very low-income homeowners who cannot obtain other credit to repair or rehabilitate their properties," together with "grants to homeowners age 62 or older who cannot obtain a loan to correct health and safety hazards or to make the unit accessible to household members with disabilities." So a homeowner told they might qualify for "a USDA loan" for repairs is being pointed at a different program from the one a buyer is offered, under a different section of the same statute.

The income test is not what it is usually reported to be. Guaranteed-loan eligibility at 7 CFR 3555.151(a) says only that "the household's adjusted income must not exceed the applicable moderate income limit," and the definition of moderate income at 7 CFR 3555.10 is a greater-of test with three limbs: 115 percent of the United States median family income, the average of the statewide and state non-metro median family income, or 115/80ths of the area low-income limit adjusted for household size for the county or metropolitan area where the property sits. The widely repeated shorthand, that the limit is 115 percent of the area median income, is not what the regulation says and can be materially wrong in a low-income county, where the third limb or the national figure may set a higher ceiling than local incomes would. The published limits for a specific county are on the Rural Development site, and they are what to check.

Household income, not borrower income. The regulation treats these as two different numbers, and confusing them is the commonest reason an application fails after the borrower was told they qualified. Repayment income is what the parties to the promissory note are expected to receive, and it is used to judge whether the loan can be repaid. Annual income under 7 CFR 3555.152(b) is "the income of all household members, regardless of whether they will be parties to the promissory note." An adult relative living in the home who will not be on the loan still counts toward the eligibility ceiling.

Two fees, and the regulation's name for one of them is the name people attach to the other. 7 CFR 3555.107(g) requires "a nonrefundable up-front guarantee fee," which "will not exceed 3.5 percent of the principal obligation." Subsection (h) then authorizes a separate "annual fee," which may "not exceed 0.5 percent of the average annual scheduled unpaid principal balance of the loan for the life of the loan." Both may be passed on to the borrower. Those are the regulatory ceilings; the rates actually charged are set by Rural Development notice, have been well below the ceilings, and change, so the current figures come from Rural Development rather than from any summary. The point to carry away is structural: a no-down-payment USDA guaranteed loan costs an up-front charge plus an ongoing one, and the ongoing one does not end when the balance falls, unlike private mortgage insurance on a conventional loan.

Payment assistance is the direct program's real benefit, and it is a loan against the future. Under 7 CFR 3550.68, payment assistance can reduce a borrower's effective cost substantially, and the regulation caps it: "payment assistance may not exceed the amount necessary if the loan were amortized at an interest rate of one percent." The same section states the condition most borrowers underweight, that "payment subsidies are subject to recapture when the borrower transfers title or ceases to occupy the property." The subsidy is not forgiven by the passage of time. It accumulates as an amount owed back on sale, which changes what a later sale actually nets and is worth understanding before the first payment rather than at closing on the way out.

On the guaranteed side, a borrower applies to an approved lender, which underwrites the loan through Rural Development's automated system and confirms three things: that the property sits in an eligible rural area, that household adjusted income is within the applicable moderate income limit, and that the borrower will occupy the home as a principal residence. The lender closes the loan and requests the guarantee within thirty days. On the direct side the borrower applies to Rural Development itself, which underwrites, lends, and administers any payment subsidy.

A hypothetical example of the two-fee structure, computed at the regulatory ceilings rather than at any current rate. A borrower takes a $200,000 guaranteed loan. At the up-front maximum of 3.5 percent, the guarantee fee would be $7,000, which the lender may pass on and which is commonly financed into the loan rather than paid in cash. At the annual maximum of 0.5 percent applied to an average scheduled balance of $198,000 in the first year, the annual fee would be $990, or $82.50 a month added to the payment. Both figures are ceilings the regulation sets, not the charges in force. The reason to work the example anyway is the shape it shows: the up-front fee is a one-time cost that can be rolled in, while the annual fee is a permanent addition to the monthly payment for as long as the loan exists.

Pros

• No down payment is required on either program, which for a household with income but no accumulated savings is the binding constraint removed.
• The annual fee ceiling is low relative to what a comparable conventional borrower with a small down payment would pay for mortgage insurance.
• The direct program's payment assistance can reduce the effective interest rate far below any market rate, and nothing else available to an ordinary buyer does that.
• Section 504 grants give homeowners aged 62 and over a route to fund health and safety repairs without taking on debt they cannot service.

Cons

• The property has to be in an area USDA classifies as rural, which rules out most of the country's housing stock by location alone.
• The annual fee runs for the life of the loan and does not fall away as equity builds, so refinancing out is the only exit from it.
• Income eligibility counts the whole household, so an adult family member's earnings can disqualify a buyer who would otherwise be well inside the limit.
• Payment assistance on a direct loan is recaptured on sale or when occupancy ends, which reduces the proceeds of a later sale.
• Both programs depend on annual appropriations, and the guaranteed program's regulation expressly contemplates a shortage of funds, in which case first-time homebuyers and veterans are served first.