How to Qualify for USDA 502 Home Loan Program

The USDA offers two types of loans for first-time home buyers under Section 502: the guaranteed loan and the direct loan. Private lenders service guaranteed loans, with the government reducing the lender’s risk by guaranteeing repayment. Direct loans target home buyers with lower incomes than those eligible for guaranteed loans. The USDA services these loans itself, and offers payment assistance subsidies and enhanced borrower protections not available for guaranteed loan applicants. The interest rate on direct loans may be reduced to as little as 1 percent, based on the borrower’s income.

Qualifying applicants for either type of loan have a reasonable credit history, but cannot be approved for a mortgage from conventional sources such as private banks or mortgage brokers. Additionally, the monthly costs associated with home ownership, including mortgage payments, taxes and insurance, should add up to less than 25 percent of their monthly income. If your income is less than 80 percent of the median income in the area where you wish to live, you may be eligible for a direct loan. Home buyers can qualify for a guaranteed loan with incomes up to 115 percent of the same median amount.

In addition to its rural location, the home purchased with a guaranteed loan must be an existing structure that meets the livability standards set forth by the Department of Housing and Urban Development for their loan programs. A direct loan, in contrast, may also be used to build a home, or to repair and renovate an existing home. Any home purchased using either loan program must be modest in size and design, and not have a fair market value that exceeds the loan limit set by the USDA for that area.

Both direct and guaranteed loans cover either 100 percent of the home’s fair market value or the actual purchase price, whichever is less. Other costs associated with the purchase of a home, including closing costs and legal fees, may be included in the loan provided the actual purchase price is less than the home’s fair market value. Successful borrowers pay back their direct loan over a period of between 33 and 38 years, depending on their income. Interest rates for direct loans are set based on the government’s cost of money, although the rate may be adjusted by subsidy based on the borrower’s income. Guaranteed loans are financed over a 30-year period with an interest rate set by the lender. The USDA charges the lender a one-time fee of 2 percent the amount of the loan for its guarantee. The lender may pass on the cost of this fee to the borrower.