If you are a rural homebuyer, you have a distinct advantage when it comes to finding the right mortgage. The USDA loan offers exceptional benefits, but only if your income doesn’t exceed the USDA’s guidelines. If you don’t qualify for a USDA loan, the next best thing is the FHA loan.
Both programs are government-backed and have flexible guidelines. They give you affordable mortgage options to help the rural homebuyer get the home they want.
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Below we’ll discuss each loan option in detail.
USDA Loans for the Rural Homebuyer
USDA loans are known as the ‘rural homebuyer loan.’ That’s probably because you can only use USDA loans in rural areas. No, this doesn’t mean you have to live out in the middle of cornfields. The USDA bases their rural requirements on the latest census tract, which could be many years ago depending on when you apply.
If you do find a home within their boundaries, you’ll have to meet the following requirements to get approved:
- Household income – The first and most important requirement is the amount of your household income. It cannot exceed the USDA’s limits. The USDA calculates the income of every adult living in your home, whether they are on the loan or not. They then compare that total income to average for the area. If your total household income exceeds 115% of the area’s income, you can’t use the USDA loan.
- Qualifying income – Once you are ‘eligible’ for the program, you have to qualify. Lenders derive this income from the borrower and co-borrower, not the entire household. You’ll have to meet the USDA’s debt ratio guidelines, which are 29% housing ratios and 41% total debt ratios.
- Credit score – You’ll need at least a 640 credit score for the USDA to consider your loan application. However, if you have a 660 score or higher, you’ll get more streamlined treatment during the underwriting process.
- Owner occupancy – You’ll have to prove that you’ll live in the home you purchase with USDA financing as your primary residence. Basically this means you can’t have another residence in the near vicinity. If you do, it can’t be a home that you could comfortably live in right now. For example, if you want to buy a 3-bedroom home to accommodate your family, you can’t have a 3-bedroom home nearby already. You do not, however, have to be a first-time homebuyer.
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If you meet these requirements, you’ll have the benefit of getting a home with no down payment. The USDA even allows you to roll closing costs into your loan if the value of the home exceeds the purchase price.
FHA Loans for the Rural Homebuyer
What happens if you don’t meet the income requirements for the USDA loan? You can turn to the FHA loan. Still a government-backed loan, this loan option has similar guidelines, but requires a higher down payment.
The FHA loan requires a 3.5% down payment. However, the funds can come from you or as a gift from a relative or employer. Either way, you have to make sure you can put that 3.5% down, plus cover the closing costs.
If you can manage the down payment, you’ll need to meet the following requirements:
- Debt ratios – The FHA doesn’t have a maximum income limit to qualify for the program. Instead, they look at your debt ratios. They allow a maximum 31% housing ratio and 43% back-end ratio.
- Credit score – The FHA is slightly more lenient when it comes to credit scores. According to the FHA, a credit score as low as 580 qualifies for the program. However, many lenders require slightly higher standards to make sure they are not taking on a big risk. Because the FHA guarantees the loans, though, you may find lenders willing to go as low as 580.
- Owner occupancy – Just like the USDA loan, you must prove you will live in the property as your primary residence. FHA loans are not for investment or second homes. It’s strictly a program that guarantees funds for lenders in order for low to middle-income families to purchase a home.
- Stable income – The FHA prefers if your income is stable for the last two years. If you did change jobs and/or income during that time, an increase is much better than a decrease. The lender will likely use a 2-year average of your income if there was a decrease in order to make sure they don’t approve you for a loan you cannot afford.
Both the USDA and FHA loans charge mortgage insurance upfront and on an annual basis.
- USDA loan upfront mortgage insurance – Borrowers pay 1% of the loan amount at the closing for a USDA loan
- FHA loan upfront mortgage insurance – Borrowers pay 1.75% of the loan amount at the closing for an FHA loan.
- USDA loan annual mortgage insurance – The USDA charges 0.35% of the outstanding principal balance each year. They then charge the borrower 1/12th of that amount each month.
- FHA loan annual mortgage insurance – The FHA charges 0.85% of the outstanding principal balance each year, charging the borrower 1/12th of the balance each month.
The main difference for a rural homebuyer between the two programs is the total household income. If you are eligible for the USDA loan, it may make more sense as it’s often less expensive. If you don’t qualify, though, the FHA loan is a great alternative as it has similar flexible underwriting guidelines and low fees.