Understanding USDA Loans: Direct vs. Guaranteed

Designed to promote homeownership in rural areas, USDA loans offer a unique financing option for homebuyers, typically with little to no down payment.

There are two types of USDA loans: the USDA direct loan and the USDA guaranteed loan. While both programs were established by the USDA to promote homeownership in rural and suburban areas, they serve distinct purposes and are designed for different financial circumstances.

In this article, we’ll clarify the differences between the two, and help you determine which option may best suit your needs.

In this article (Skip to...)

• What are USDA loans?
• Direct USDA
• Guaranteed USDA
• Comparison
• The bottom line

What are USDA loans?

Divided into two types (Direct and Guaranteed), USDA loans are government-backed mortgages offered through the United States Department of Agriculture (USDA) to encourage homeownership in rural and suburban areas.

The goal of the program is to make it easier for individuals and families with moderate or low incomes to purchase homes in areas that may be underserved by traditional lenders.

USDA loans offer significant benefits, including the potential for zero down payment, competitive interest rates, and no mortgage insurance costs.

USDA loans do, however, have a fee that’s similar to mortgage insurance known as a guarantee fee. The USDA guarantee fee, sometimes referred to as a funding fee, comes in both an upfront fee and an annual fee.

USDA loans’ upfront fee is equal to 1% of the total loan amount. Despite being called an “upfront” fee, homebuyers don’t have to pay it out-of-pocket at closing. Instead, they can roll the cost into their loan.

USDA loans’ annual fee, which is 0.35% of your loan balance, is divided into monthly payments and added to your monthly mortgage payment.

Direct USDA loans

Direct USDA loans, also known as Section 502 Direct Loans, are issued directly by the USDA and are aimed at low- to very-low-income homebuyers. These loans are designed to help individuals and families purchase safe and sanitary housing in rural areas, who might not qualify for conventional financing.

USDA direct loans are less widely available, but it’s possible to obtain one through the USDA directly – hence the name “direct”. In this scenario, the USDA serves as the lender and provides the funds for purchasing the property. Instead of working with a private lender, you’ll deal directly with the USDA.

Eligibility Criteria

To qualify for a direct USDA loan, you must meet certain income limits, which are based on household size and the area’s median income. Specifically, your income must fall within the low or very low-income range, meaning up to 80% of the area median income (AMI).

You’ll need to meet the credit requirements imposed by the private lender to close on the loan. Additionally, the USDA will generally require you to have a debt-to-income ratio (DTI) of 41% or less.

The home being purchased must be located in an eligible rural area, as defined by the USDA.

USDA direct loans have an additional requirement that the home must be less than 2,000 square feet.

Benefits of Direct USDA loans

• Low or No Down Payment. Mortgage borrowers can typically finance up to 100% of the home’s value.
• Low Interest Rates: One of the most attractive features of direct USDA loans is the low interest rates offered. In fact, the USDA recently announced a rate reduction for the Single Family Housing Direct Loan (SFH Direct) program.*
• Extended Repayment Terms. Loans can be repaid over a 33-year or 38-year period, depending on the borrower’s income, which helps to further reduce monthly payments.
• Lower Mortgage Insurance Costs. USDA loans often have lower mortgage insurance (technically referred to as guarantee fees) compared to FHA loans, helping mortgage borrowers save money over time.

*Recent Interest Rate Update

As of 2024, the USDA has lowered interest rates for the SFH Direct Loan Program to make homeownership more affordable for rural buyers. This rate reduction further emphasizes the government’s commitment to promoting affordable housing for low-income families in rural areas.

Guaranteed USDA loans

Unlike direct loans, Guaranteed USDA loans are provided by private lenders, such as banks and credit unions, but are still backed by the USDA. This guarantee from the USDA reduces the lender’s risk, allowing them to offer more competitive rates and better terms to borrowers who might not qualify for conventional loans.

Eligibility criteria

Guaranteed loans are designed for moderate-income borrowers whose income typically does not exceed 115% of the area median income.

The USDA guaranteed loan does not have a specific minimum credit score requirement and is assessed on a case-by-case basis. However, certain credit issues, like delinquent child support, may disqualify an applicant.

Like direct loans, you’ll typically need to have a debt-to-income ratio of 41% or less, and the property being purchased must be located in an eligible rural area. However, the income limits for guaranteed loans are higher, allowing a broader range of homebuyers to qualify.

Benefits of Guaranteed USDA loans

• Competitive Interest Rates. While interest rates on guaranteed loans may not be as low as those for direct loans, they are still competitive, especially when compared to conventional mortgage options.
• More Lender Options. Because guaranteed loans are offered by a variety of lending institutions, buyers have greater flexibility and can shop around for the best rates and terms.
• No Down Payment Required. Like direct loans, guaranteed USDA loans typically allow you to finance up to 100% of the home’s value, meaning no down payment is needed in most cases.
• Flexible Credit Requirements. Although borrowers need to meet certain credit standards, USDA loans often have more flexible credit requirements than conventional loans, making homeownership accessible to more people.

Direct USDA vs Guaranteed USDA

When deciding between a direct and guaranteed USDA loan, it’s important to compare the key differences in terms of interest rates, eligibility, the application process, and the pros and cons of each type.

Pros of Direct USDA loans

• Lower interest rates
• Longer repayment terms
• No down payment requirements
• Closing costs may be rolled into the loan
• Ideal for very low-income borrowers

Cons of Direct USDA loans

• Limited availability (only for very low-income buyers)
• Must apply directly through the USDA, which can be a longer process
• Additional fees (one-time 1% guarantee fee and 0.35% annual fee)

Pros of Guaranteed USDA loans

• More widely available
• No down payment requirements
• Closing costs may be rolled into the loan
• Competitive rates from a range of lenders

Cons of Direct USDA loans

• Interest rates are higher than direct loans
• Slightly stricter credit requirements than direct loans
• Additional fees (one-time 1% guarantee fee and 0.35% annual fee)

Making the right choice

Choosing between a Direct USDA loan and a Guaranteed USDA loan depends largely on your financial situation, income level, and homeownership goals.

If your income falls within the low to very-low range and you qualify for a direct loan, you could benefit from the lower interest rates and extended repayment terms. However, if your income exceeds the limits for direct loans but still qualifies for a guaranteed loan, you’ll have access to competitive rates from a variety of lenders, giving you more flexibility.

It’s a good idea to consult with a lender who specializes in USDA loans to explore your options and determine which program is the best fit for your specific situation.

The bottom line

For homebuyers interested in purchasing a home in rural areas, USDA loans provide an excellent financing option that can make homeownership more accessible.

Whether you opt for a Direct USDA loan, which offers lower interest rates for low-income borrowers, or a Guaranteed USDA loan, which provides more flexibility through private lenders, both programs offer unique benefits that cater to different needs.

Be sure to review your options with a USDA loan specialist to choose the loan that best aligns with your financial goals and long-term plans.