usda construction loan

Understanding USDA Construction Loans For New Construction

You’ve had it with the market. You’ve decided that you just want to buy some land and build a house from scratch.

That’s fine—great even—but how do you finance it? How do you buy a house that doesn’t exist?

A USDA construction loan can help, but only if you meet its requirements. And if you do meet the given requirements, it can be an excellent opportunity to build the house of your dreams.

Let’s talk about USDA construction loans for new construction houses.

What is a USDA Construction Loan?

The United States Department of Agriculture (USDA) offers a construction loan program for new construction and rural development. This program is available to qualified borrowers who are looking to build a home in an eligible rural area. A USDA construction loan can be used to finance the cost of the construction, lot purchase, and site improvements.

On the surface, this is a fantastic deal. It’s a one-time close loan; you get everything rolled into a single lending package. Without a one-time close loan, you can find yourself with a land loan on top of a mortgage loan-something that’s generally pretty costly.

usda construction loan

The Benefits of a USDA Construction Loan

There are a number of benefits to using a USDA construction loan for your new home. Some of the key benefits include:

  • You can use it for both single and multi-family homes.
  • Financing is available for both manufactured and modular homes.
  • It’s easy to find eligible properties if you’re looking for a rural area.
  • Unlike a conventional loan, there’s no down payment required for a USDA mortgage.
  • Many of your closing costs can be folded into the loan itself.

So if you’re looking to build a home in the country, a USDA construction loan could be a great option for you. But not everyone will meet the fairly stringent requirements of the USDA loan program.

The Requirements for a USDA Construction Loan?

Now that we’ve talked about some of the benefits of a USDA construction loan, let’s go over some of the requirements.

First, you’ll need to find an eligible rural area. The USDA has a website that you can use to search for eligible areas. Once you’ve found an eligible area, you’ll need to find an eligible property. The USDA has specific requirements for eligible properties, which you can read about on their website.

In addition to finding an eligible area and property, you’ll also need to meet the following requirements:

  • You must have a credit score of 640 or higher (while the USDA doesn’t have a strict credit score requirement, lenders do).
  • Your debt-to-income ratio must be below 41% to qualify for a USDA mortgage loan.
  • You must have sufficient income to make your monthly payments.
  • You will need to reside in the house as a primary residence upon completion.
  • You will need to use a USDA-approved contractor.
  • You will need to have a new construction warranty in place.
  • You cannot exceed the USDA income limit for the year.
  • You cannot have had a bankruptcy within the last two years.

If you meet these requirements, a USDA construction loan may be the right choice for you. But… There can be some challenges when trying to acquire a USDA loan, including the above-mentioned income eligibility.

usda construction loan

USDA Loan Income Eligibility

USDA loan income eligibility varies. In fact, it varies so significantly that there’s a tool available online to help you figure it out.

USDA loan income limits are generally capped at around 115% of a household’s average median income. So, you can’t make significantly more than the median household within your area to apply for any USDA loan, including a USDA direct loan for existing homes.

The standard income limit for 1 to 4 member households is $91,900, whereas the limit for 5 to 8 member households is $121,300. If you’re in a higher earning area, that will be higher; if you’re in a low-income flyover state, it will be lower.

The Practical Constraints of a USDA Loan

A USDA loan looks fantastic on paper. It’s 100% financing. It includes things like inspection fees, builder’s insurance, design plans, permits, and utility and septic costs.

So, why aren’t more people using them?

There are a few issues with a USDA loan. First, they do have income requirements; the borrower will need to be relatively low-to-moderate income to get a USDA loan. Second, they have strict financing requirements. Not every bank provides USDA loans and not every builder is USDA-approved. So, it takes a lot of time to organize and it isn’t always a sure thing. Finally, it does only apply to rural locations. You need to intend to move to a rural area to use this type of loan.

If you can’t get a USDA Guaranteed Loan, however, you might still be able to get an FHA loan, a VA loan, or a conventional home loan. You can also look at more circuitous and creative routes to get a property, such as looking into existing home foreclosures or getting a manufactured home loan directly from a seller.

Should You Even Build a New Home Instead of Buying?

Before you even figure out your financing, you need to determine whether buying a new home is really the right solution for you.

There are a lot of benefits to buying an existing home. First, it’s much simpler and easier than going through the construction process. You don’t have to worry about building permits or hiring contractors.

Second, you don’t need to live in a rural area to buy an existing home. There are plenty of great homes located near urban centers. Quite a lot of people with a low-to-moderate income will not enjoy a 30-minute commute to the nearest township.

On the other hand, building a new home has its own set of benefits. You can get exactly what you want – from lot size to style – without worrying about limitations or compromises. And if you build a new home, you don’t have to deal with all the issues that come with an older home, like maintenance costs and sudden repairs.

usda construction loan map

Source: CDC.gov

And What Counts as a “Rural” Property?

“I want to move to the suburbs. Does that count as ‘rural’ for a USDA loan?”

It may feel rural, but probably not. The USDA’s website has a great tool that lets you type in an address and see if it qualifies for a USDA loan.

Generally speaking, suburban areas near major urban centers do not qualify as rural for USDA loans. But, there are some exceptions and special cases that may allow you to qualify in a suburban or even urban area.

The USDA Loan: A Great Loan for Those Who Can Get It

The bottom line is that a USDA construction loan is an absolutely life-changing tool… for those who qualify. USDA loans are incredibly situation-specific.

If you want to move somewhere rural, if you want to build your own home, if you can find the right lender and builder, and if you are in a low-to-moderate income household… then a USDA home loan is the right package for you.

But there are other alternatives. Traditional construction loans, FHA loans, VA loans – if you want a house, you can get into a house. It just depends on your needs, wants, and restrictions. A USDA loan is an excellent tool to consider, but if you don’t qualify (or it won’t work for you), don’t despair.

FAQs

What are the cons of a USDA construction loan?

The main downside of a USDA construction loan is that it can be difficult to qualify for. You’ll need to have a low-to-moderate income, and you’ll need to be planning to build in a rural area. Very few banks offer this product because it’s so difficult to underwrite-and you’re going to have to find a builder who will work with you to meet the requirements of the loan.

Is it hard to get approved for a USDA loan?

Yes, it can be hard to get approved for a USDA loan. You’ll need to provide proof of income, have a good credit history, and show that you plan to build or move to a rural area. The combination of relatively good credit history and low-to-moderate income can trip up some otherwise great borrowers, as it requires that you be financially stable… but not too financially stable.

What credit score do you need for a USDA loan?

The USDA website lists no minimum score but does advise that most lenders will require at least a score of 640. Some lenders may set the bar higher at 660 or even 700. But in reality, what matters most is your income relative to your debt. If you have good credit but not a lot of savings, or if you make just enough to support your debt, then you may have a very difficult time qualifying for a USDA loan.

Do you need to own land for a USDA loan?

No, you don’t need to own land for a USDA loan. You can use the loan to buy land along with your construction. But know that because the USDA loan process is lengthy, it can be difficult to get a seller to accept a USDA loan. Quite a lot of land sales are conducted in cash.

Why would a USDA loan get denied?

There are a few common reasons why USDA loans get denied. The most important is that your income must be low enough to qualify for a rural area, but not so low that you would also qualify for public assistance programs like SNAP. Other reasons include having too much debt relative to your income, having recent credit issues, or having an incomplete application.

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