Buying a rural home with no down payment is possible with the USDA loan. Many people qualify for this loan and don’t realize it. If you could purchase a home just outside of the city limits with no down payment and low closing costs, would you? Most people would, they just don’t know how it works. Here we talk about the most misunderstood part of the USDA loan – the mortgage funding fee.
What is the USDA Mortgage Funding Fee?
The USDA is a government agency that provides these loans. However, they don’t fund them. They guarantee them for lenders. This makes it possible for lenders to provide loans to low to moderate-income families. These families don’t need excellent credit or even low debt ratios. What they need is low enough income to be eligible for the program. However, the income must cover their monthly obligations and leave plenty left over for daily living expenses. The USDA loan has much more liberal guidelines than many other loans. In order to provide these benefits, though, the USDA must charge a funding fee.
The fee the USDA charges helps them stay in business. They use the funds to stock their reserve account. This is the money they use to bail a lender out of a mortgage default. The USDA has the final say in which mortgage applications get approved, though. This way they can monitor and hopefully minimize the default lenders experience.
How Much is the Funding Fee?
Right now, USDA borrowers have the good fortune of low fees. Recently the upfront fee decreased from 2.75% to just 1% of the loan amount. In order to calculate how much you owe, you must know your full loan amount. You can figure this out with the following:
- Purchase price of the home
- Amount of the down payment (if any)
- Amount of the closing costs
Once you deduct any money you put down on the home from the purchase price and add in the closing costs, you have your loan amount.
Now, take the loan amount and multiply it by 1%. Here’s an example:
- Purchase price $125,000
- Down payment $0
- Closing costs $1,500
The total loan amount equals $126,500. Take $126,500 x 1% and you get a funding fee of $1,265. You then have the choice to pay this amount at the closing or roll it into the loan amount.
If you pay it at the closing, be prepared to verify the assets you use to pay the fee. The lender must make sure they are your funds and that they are seasoned. This means that they sat in your account for at least 6 months, in most cases.
Paying the Annual Fee
The USDA loan requires more than just the funding fee, however. They also charge an annual fee. While the lender pays this fee on your behalf once a year, they charge you on a monthly basis. This helps make the fee more affordable. It also helps ensure that it is paid on time. In order to calculate this fee, you must know the amount of your outstanding balance each year. You can figure your original annual fee by taking the full loan amount and multiplying it by 0.35%, as this is the fee right now.
For example, if you took out a $100,000 loan, you would owe $350 per year or $29.16 per month. However, after the first 12 months, your outstanding principal balance should be slightly lower. The lender will take the average outstanding principal balance over the last 12 months. You can do this by looking at your amortization table and adding the last 12 months’ of outstanding balances. You then divide this number by 12. This gives you the average outstanding balance for the year. Let’s say in the beginning this amount equals $99.400. This might not seem low enough, but in the beginning, you pay very little principal and a lot more interest. As time goes on, you pay more principal than interest. On the $99,400, you would owe $28.99 per month. This number would then decrease each year.
Watch Your Debt Ratio
Keep in mind, your debt ratio is affected by the upfront funding fee and mortgage insurance fee. However, if you pay the upfront fee out of your own pocket, it doesn’t affect your debt ratio. The annual fee does, though. Because you owe this amount each month, it takes away from your gross monthly income. Luckily, the percentage is low enough that it usually does not affect debt ratios too much. The USDA does not put a lot of focus on debt ratios and they have flexible guidelines, so many borrowers are not affected by it.
Knowing how to calculate the funding fee and annual insurance fee can help you determine if the USDA loan is right for you. No matter which lender you choose, you will pay this fee. It is non-negotiable and is paid directly to the USDA. This is how they continue to be able to make loans for the low to moderate-income families.
Remember, you must qualify based on your household income. This means the income from every adult in your home. The amount cannot exceed 115% of the median income for your area. You can find this amount on the USDA’s website. You also must purchase a “rural” home. Again, this is determined by the USDA. It is worth looking at their map to see which areas are rural as they may surprise you. Oftentimes areas just outside of the suburbs qualify simply because of their low population rates. The eligible areas change with every census, so make sure you look at the most up-to-date information to see if the property you wish to purchase is eligible. The USDA program provides a very simple and inexpensive way to finance the home you want to own.