USDA Is Probably More Affordable Than FHA
The popular USDA home loan program just got a lot more affordable.
In a surprise move, the United States Department of Agriculture (USDA) lowered upfront and monthly fees for its home loan program, effective October 1, 2016.
This mortgage program is extremely popular with first-time home buyers.
The biggest reason: it requires zero downpayment. But the Rural Development (RD) loan program, as it is also known, is a favorite because it comes with cheaper monthly mortgage insurance fees than do FHA loans.
USDA fees have dropped even further.
The USDA loan is now one of the most affordable home loans available, second only to the veteran-exclusive VA home loan.
A USDA home loan can make owning a home less expensive than renting one.
New home buyers who have never heard of the program probably will in late-2016 and into 2017; this mortgage could be their ticket to homeownership.
What Is A USDA Loan?
The purpose of the USDA mortgage is to promote homeownership in rural areas.
However, the definition of “rural” is quite liberal. Many suburban neighborhoods are eligible for USDA financing. Buyers often use this program just outside of major metropolitan areas.
The loan offers 100 percent financing, meaning no downpayment is required. Downpayment is one of the biggest barriers to entry for first-time home buyers, but a USDA mortgage eliminates that obstacle.
Potential buyers often assume that a high credit score is needed for USDA. The lower the downpayment, the reasoning goes, the higher credit score someone would need.
This isn’t the case with USDA. Applicants with credits scores down to 640 are eligible.
Strong government backing allows lenders to approve mortgages that would not qualify under guidelines for other programs.
The surprising thing about these loans is that upfront and monthly mortgage insurance costs are not sky-high. USDA financing comes with cheaper mortgage insurance than do FHA mortgage loans.
On a $250,000 mortgage, a USDA loan now costs $100 per month less in mortgage insurance fees than FHA financing.
The amount by which USDA cut its own fees is surprising. It could actually help many homeowners move from “turned down” to “qualified.”
New 2016 USDA Upfront & Monthly Fees
Similar to FHA, the USDA mortgage requires two types of mortgage insurance: an upfront guarantee fee and a monthly fee.
The term “guarantee” simply refers to USDA’s loan backing that allows lenders to issue loans according to its guidelines.
The upfront guarantee fee before the change was 2.75 percent of the loan amount. The “annual fee” was 0.50 percent, paid in twelve equal installments and included in each mortgage payment.
Starting on October 1, 2016, the upfront fee has been updated.
- Former upfront fee: 2.75%
- New upfront fee: 1.00%
The monthly fee also dropped.
- Former annual fee: 0.50%
- New annual fee: 0.35%
The changes will be in effect from October 1, 2016 to September 30, 2017. Typically, USDA re-examines financials of previous fee changes then raises, holds, or reduces fees accordingly. If loans in USDA’s portfolio perform well, another drop could come in 2017.
But the 2016 reductions alone equal big savings for USDA home buyers.
USDA Upfront Guarantee Fee Savings
The most significant change to home buyers will be the upfront fee. The fee is typically added to the loan balance, rather than paid in cash.
This is an advantageous arrangement, but it adds to the homeowner’s final loan amount. At the former upfront fee of 2.75 percent, a USDA loan will add more than $6,800 in loan amount on a $250,000 home purchase.
But the The fee reduction reduces the amount added to the loan. This translates a lower debt obligation, and lower payments.
USDA applicants will end up with lower loan amounts based on the new, lower upfront fee.
- $150,000 home purchase: $2,625 loan balance reduction
- $200,000 home purchase: $3,500 loan balance reduction
- $250,000 home purchase: $4,375 loan balance reduction
- $300,000 home purchase: $5,250 loan balance reduction
These lower loan amounts translate into reduced monthly payments as well. The payment savings on a $250,000, due to the reduced loan balance, would be about $20 per month.
USDA Monthly Fee Savings
The upfront fee is not the only reduction effective starting October 2016. The annual fee is dropping too.
The annual fee was formerly equal to 0.50 percent of the loan balance, paid in 12 “pieces” and included in each house payment.
That equals about $40 per month for every $100,000 borrowed.
That monthly rate is dropping to 0.35 percent annually, or about $30 per $100,000 in loan balance.
Accounting for reductions in both upfront and annual fees, USDA home buyers will save about $20 per month total per $100,000 borrowed.
This could mean the difference between being turned down and getting approved for some USDA home buyers. To qualify, you must meet debt-to-income requirements. Your income must be enough to sustain future monthly payments on credit accounts, including your home loan.
For instance, a home buyer is “allowed” maximum debt payments of 41% of her income. But, she is at 42%, and the lender can’t approve the loan as-is.
With the new, lower mortgage insurance fees, her “debt-to income ratio” could fall enough to be approved.
Home buyers can seldom increase their income, but they can reduce payments by choosing a USDA loan once these cost reductions take effect.
USDA Reverses History Of Fee Hikes
The USDA fee reduction announcement is in stark contrast to the agency’s history of increasing costs.
Less than a year ago, on October 1, 2015, the upfront mortgage insurance premium was lifted from 2 percent to 2.75 percent.
Here is the history of USDA fee changes:
- Prior to October 1, 2011: upfront fee of 3.5% and no annual fee
- October 1, 2011: upfront fee of 2.0% and annual fee of 0.30%
- October 1, 2012: upfront fee of 2.0% and annual fee of 0.40%
- October 1, 2014: upfront fee of 2.0% and annual fee of 0.50%
- October 1, 2015: upfront fee of 2.75% and annual fee of 0.50%
- October 1, 2016: upfront fee of 1.0% and annual fee of 0.35%
The fact that USDA is now lowering their fees is a testament to the health of the housing and mortgage markets.
As the housing market recovers, the USDA program costs less to operate and sustain. The savings are passed on to USDA buyers.
Who Is Eligible For A USDA Loan?
USDA loan eligibility is based largely on geographical location of the home.
The agency publishes maps that detail areas in which applicants can buy a house with a USDA loan. A full 97% of U.S. land mass is eligible for the USDA loan program.
Besides this requirement, an applicant must:
- Meet income-eligibility
- Occupy the dwelling as their primary residence
- Be a U.S. citizen, foreign national, or qualified alien
- Purchase a safe, livable property
Every year, home buyers opt for the more expensive program, even when they are buying in USDA-eligible areas. Consumers often haven’t heard about the program, or perhaps, their chosen lender doesn’t offer it.
If you are buying in a suburban or rural area, it pays to check USDA eligibility maps. If your lender only offers you FHA, find another lender who has experience with USDA mortgages.
Choosing USDA will save you the 3.5% downpayment that FHA requires. And, now that 2016-2017 mortgage insurance fees are in effect, you will save money each month over FHA, as long you hold the home and mortgage.
Eligible home buyers should weigh the benefits of a USDA loan.
What Are Today’s USDA Mortgage Rates?
USDA offers some of the lowest rates available, thanks to strong government backing. Rates are as low or lower than those of FHA.
Get a USDA rate quote for your upcoming home purchase. It takes just minutes to get started, and you could receive a pre-approval in just hours.