USDA Guaranteed Loans vs USDA Direct Loans
In the spring of 1935, President Franklin D. Roosevelt signed an executive order that established the “Resettlement Administration.” The president’s aim was to create an agency devoted to relocating distressed families during the Depression. Other duties assigned to the agency included emergency loans to farmers who required land and equipment if they hoped to remain in business.
Fast forward nearly 60 years and the Department of Agriculture experiences reorganization and the USDA Rural Development program is born. The agency and the program were tasked with providing finance programs for rural housing that fell outside of the farm programs handled by the Farmers Home Administration (FmHA).
Today’s Rural Development agency is, as the USDA says, “the venture capitalist for rural America,” making money available to low-to-moderate-income families to build, rehab, purchase and refinance homes within the rural areas it serves. This money comes in the form of direct loans, loan guarantees and grants.
Although the Rural Housing Service (RHS) main office is located in Washington, D.C., there are field offices scattered across the country to assist individuals with purchasing homes in rural areas. USDA named the loans Section 502 and several types of loans fall under the section’s umbrella: the Single Family Housing Direct Loan and the Single Family Housing Guaranteed Loan programs. Let’s take a look at these loans individually.
The USDA Direct Loan – Section 502 Direct Loan Overview
The “direct” part of the Homeownership Direct Loan Program refers to the fact that the applicant is borrowing directly from the USDA, or the government, or the taxpayer, however one chooses to view it. Cost are kept to a minimal as well, aside from just not having to pay a down payment for the loan, because the USDA handles the closing those costs.
502 Direct Loan Subsidies
Direct Loan payments are typically subsidized based on income. If the applicant qualifies, the first subsidy payment is distributed at the time the loan is made and then monthly thereafter. There are three types of subsidies:
- Interest Credit – USDA subsidizes part of the interest payment on the loan. The borrower continues to receive this credit as long as he or she remains eligible.
- Payment Assistance 1 – Payment assistance is based on the difference between the monthly payment according to the promissory note and the amount the borrower must pay based on income. The USDA uses a formula to determine this amount.
- Payment Assistance 2 – This category is for eligible buyers that do not receive interest credit and don’t fall within the parameters for Payment Assistance 1.
All payment subsidy recipients must occupy the house during the loan’s term, although he or she may be temporarily absent for a period of 6 months, with permission from the Rural Development Agency.
Some of the reasons for an absence that the Agency may entertain include seasonal employment out of the area, hospitalization and military deployment. The borrower cannot rent the property to another individual during these periods of absence nor at any other time. The borrower’s situation is reviewed annually and he or she may be added to or removed from any of the subsidy programs.
Finally, rent subsidies must be paid back when the house is sold or if the homeowner ceases to meet the USDA’s occupancy requirements.
Section 502 Direct Loan Eligibility
Applicants for the 502 direct loan must have what the USDA describes as “low to very-low incomes.” Very low income, for the purposes of the direct loan, is that which falls below 50 percent of the area median income (AMI) while low income is defined by the government as between 50 and 80 percent of the AMI.
- Applicants must be without satisfactory housing and must be able to afford house payments, including insurance and taxes. The USDA, however, offers a payment subsidy.
- Applicants must prove that they have attempted to obtain credit elsewhere but were unable.
- A “reasonable” credit history is required.
Section 502 Direct Loan Terms
The beauty of the direct loan is that the terms are dictated by the borrower’s income, but the typical term is up to 33 years. Borrowers with incomes below 60 percent of the Area Median Income (AMI), however, qualify for a 38-year term, provided they can prove they can’t afford the 33 year-term payments.
Section 502 Direct Loan Standards
Just as the borrower must pass muster for the loan, so must the home that he or she wishes to purchase. The basic standards require that the house be modest for the area in size, design and price.
- The house’s market value must not be in excess of the loan limit set for the area.
- The house does not have what the USDA calls “prohibited features,” such as a swimming pool.
- The house must be considered modest for the area.
- The house must meet the voluntary national model building code adopted by the state and the USDA’s Housing and Community Facilities Programs (HCFP) thermal and site standards.
The USDA Guaranteed Loan – Section 502 Guaranteed Loan Overview
The USDA Section 502 Guaranteed Loan is like an FHA or VA loan in that the loan is obtained from a lender and the USDA guarantees its repayment. Because of the guarantee, lenders are more flexible in their requirements for these loans. Closing costs, however, will be higher than those of the direct loan.
If you are concerned with out-of-pocket expenses, we will negotiate with the seller to pay a percentage of your closing costs. Even if the seller refuses, our combined USDA loan expertise and experience typically finds a way to cut down on at least some of our clients’ out-of-pocket expenses.
Section 502 Guaranteed Loan Eligibility
While lenders have their own loan requirements, the following are USDA’s eligibility requirements for the guaranteed loan:
- Applicants must occupy the home as their primary residence.
- The program is open only to U.S. citizens or non-citizen nationals.
- Income may be up to 115 percent of the AMI.
- Families must not have satisfactory housing but be able to prove that they can afford to make the mortgage payments, including insurance and taxes.
- Applicants must have “reasonable” credit histories.
- Applicants must use a Single Family Housing Guaranteed Loan approved lender. That would be us!
Section 502 Guaranteed Loan Terms
USDA guaranteed loans are 30-year loans with an interest rate set by the lender. Like the direct loan, there is no down payment required. Section 502 Guaranteed Loan Standards Like the direct loan standards, USDA requires homes purchased with the guaranteed loan to be modest in design, size and cost. They must meet the voluntary national model building code and new manufactured housing must be permanently installed.
We’re always available to answer questions about the amazing USDA loan program, so don’t hesitate to contact us.