A mortgage with no down payment must charge PMI, right? If you are talking about USDA loans, there isn’t Private Mortgage Insurance. However, you will pay other fees. Here we help you understand what you will pay and for how long. Then you can make an informed decision regarding USDA financing.
What Does the USDA Charge?
Just because the USDA doesn’t charge PMI, doesn’t mean they don’t charge other fees. Right now, you’ll pay an upfront funding fee. You’ll also pay annual mortgage insurance. These fees help the USDA stay in business. They put the money collected in what they call reserves. These reserves pay for loans that default. Because the USDA doesn’t fund loans, but rather guarantees them, they need money set aside. If a borrower defaults on their loan, the USDA pays the lender back a portion of the money lost.
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Right now, the fees are as follows:
- Upfront funding fee – 1% of the loan amount paid at the closing or wrapped into the loan
- Annual mortgage insurance – 0.35 of the outstanding loan amount paid in your mortgage payment
You only pay the upfront funding fee once, unless you refinance. You pay the annual mortgage insurance every month you hold the loan, though. The amount you pay decreases slightly each year if you make your payments on time. The lender bills you 1/12th of the annual amount in your mortgage payment each month.
What’s the Benefit of the USDA Loan With No Down Payment?
Knowing these fees, you might wonder what the benefit of the program is? Should you pay the fees? Let’s look at an example of other loans with low down payment options. There aren’t any other programs that allow no down payment. They each require at least a small one:
- FHA – Requires at least 3.5% down on the home
- Conventional – Requires at least 5% down on the home (in rare cases 3% is allowed)
- VA – Doesn’t require a down payment, but you must be a veteran
The FHA works much the same way as the USDA. You pay an upfront fee and annual mortgage insurance. Right now, those fees equal 1.75% upfront and 0.85% per year. This is higher than what the USDA charges. Combine that with the higher down payment requirement and the USDA loan comes out ahead.
Conventional loans don’t have an upfront funding fee. They do, however, charge Private Mortgage Insurance. The amount charged varies based on your credit score and LTV. It’s not unusual to pay between 1 and 2% of your loan amount in PMI, though. Combining that with a 5% down payment can be costly.
Here’s a real life example:
Joe purchases a home for $150,000. His options are as follows:
- USDA – $0 money down, $1,500 upfront, $43.75 per month
- FHA – $5,250 down, $2,625 upfront, $106.25 per month
- Conventional – $7,500 down, nothing upfront, $125-$250 per month
The USDA loan definitely comes out as the least expensive. But, you pay the annual mortgage insurance for the life of the loan. The conventional loan allows you to cancel PMI once you owe less than 80% of the value of the home.
Who Qualifies for the USDA Loan?
The kicker is not everyone will qualify for the USDA loan. There’s such a thing as making too much money for this program. It’s designed for families with little income. This unique program takes into consideration the entire household income, not just the income of the borrowers. This may make some families ineligible for the program.
You can see the USDA’s guidelines here.
If you meet the income requirements, you must then meet the property requirements. You can see them here. Basically, you must purchase a rural property. It’s possible there are many more properties than you realize. Rural doesn’t mean out in the middle of nowhere for this program.
If you meet the eligibility requirements, you must then qualify for the loan. This works much like any other loan. You must meet the credit score and debt ratio guidelines. This means:
- Minimum credit score of 640 for a streamlined process (if lower a manual underwrite is necessary)
- Maximum debt ratio of 29% upfront (housing ratio)
- Maximum debt ratio of 41% on the back (total debt ratio)
- No recent collections or late payments (last 12 months)
- You don’t own any other suitable properties
- You will occupy the property as your primary residence
Overall, the USDA loan is one of the easiest. As long as you are eligible or the program, qualifying is simple. Keep in mind, you can’t use household income to qualify for the loan, though. You can only use it to verify your eligibility. You must qualify for the loan on your own or with your co-borrower.
The Final Word
Deciding whether you should use USDA financing is a personal choice. You don’t need a down payment, which really helps borrowers. But, you pay annual mortgage insurance for the life of the loan. Ask yourself the following questions:
- Do you see yourself in the home for the long-term?
- Do you think you can improve your credit so you can refinance in the future?
If you answered yes to both questions, you can eliminate the mortgage insurance in the future. Paying it in the short-term isn’t a big deal. On the $150,000, it’s only an extra $43.75 per month. That figure will decrease as you pay the principal down.
If you won’t stay in the home for the long run, paying the mortgage insurance isn’t a big issue. You won’t pay it forever, so the USDA loan offers a great chance to purchase a home for little money.
Weigh the pros and cons of each program before you decide. Consider the cost of each program now as well as for the long-run. This way you can determine what will work the best for you and your family.
