With 0% down and relatively low overall costs compared to other mortgage types, USDA loans are an incredibly affordable option for home buyers in eligible rural and suburban areas.
However, low or no down payment mortgage programs often come with costs in other areas to offset the risk that lenders assume. Most often, this comes in the form of mortgage insurance.
Do USDA loans come with mortgage insurance, and if so, how much does it cost? Let’s look at everything borrowers need to know about USDA mortgage insurance.
USDA loans are a type of mortgage. They’re geared toward lower-income home buyers in areas deemed rural by the U.S. Department of Agriculture, the agency that guarantees these loans.
You can use the USDA’s property eligibility map to see which areas are eligible for USDA loan funding. Land-wise, most of the U.S. is eligible for USDA funding; ineligible areas include cities and the areas immediately surrounding them.
USDA loans don’t require a down payment, which removes a substantial barrier to homeownership that many would-be home buyers encounter. After all, a 3% down payment – the lowest you can go on a conventional loan – on a $250,000 home is $7,500. For those on lower or middle incomes, saving that much can take a long time.
Plus, allowing borrowers to get a mortgage with 0% down means they can hold onto their cash for other purposes, such as home improvements or emergency savings.
When it comes to interest rates, USDA loans are comparable to VA loans in that these mortgages typically offer lower rates than other loan programs, such as conventional or FHA loans.
Typically, if a lender allows a borrower to buy a house with a low down payment, they’ll require that the borrower pay to insure their loan with mortgage insurance. This is because when you make a lower down payment, the risk for the lender is larger than if you made a down payment of at least 20%. Mortgage insurance helps to protect the lender.
Private mortgage insurance (PMI) is the term used for mortgage insurance on conventional (non-government-backed) loans. So no, USDA loans don’t require PMI; only conventional loans have PMI, and only on those loans where the borrower has less than 20% equity in their home.
Other loan programs may have their own forms of mortgage insurance. On FHA loans, mortgage insurance is referred to as a mortgage insurance premium (MIP). MIP is required on all FHA loans and comes with both an upfront premium and an annual premium. If you make a down payment of less than 10%, you’ll pay mortgage insurance for the life of the loan. If you make a down payment of 10% or more, you’ll pay it for 11 years.
VA loans don’t have mortgage insurance, but borrowers do pay a funding fee, which is charged as a certain percentage of the loan amount and either paid at closing or rolled into the loan amount.
So, what about USDA loans? Similar to VA loans, USDA loans don’t technically require mortgage insurance, but they do have what’s called a guarantee fee, which works like mortgage insurance in helping to guarantee the loan.
When a government agency backs a loan, such as a USDA loan or an FHA loan, they’re essentially providing insurance to the lender. If the borrower defaults on a government-backed loan, that agency pays the lender to help them recoup their losses. Fees that come with these loan programs, such as the guarantee fee, help pay for that insurance.
The USDA guarantee fee – which you may sometimes see referred to as a funding fee – comes in two parts: an upfront fee and an annual fee.
USDA loans currently come with a 1% upfront guarantee fee. This means that you’ll pay 1% of the loan amount.
Though it’s called an “upfront” fee, you don’t necessarily have to pay it upfront yourself. USDA loan borrowers can choose to include the cost of their upfront guarantee fee in their loan.
USDA loans also come with annual fees, though you won’t actually pay it once per year in a lump sum. Instead, you’ll pay a portion each month as part of your monthly mortgage payment.
The annual fee is equal to 0.35% of your loan balance.
Let’s say you’re buying a $250,000 home with no down payment. Your upfront guarantee fee is 1% of this, or $2,500.
If you choose to roll this cost into your loan rather than pay it out of pocket, the USDA will allow you to get a loan for $252,500 to cover the cost of the home as well as your guarantee fee.
Then comes your annual fee: 0.35% of $252,500 is $883.75. You’ll pay this over the course of the year, so divided by 12 months, your monthly fee will be equal to $73.65.
How do the costs of USDA loans compare to other mortgage types? Let’s look at the typical costs that you’ll pay when purchasing a home with each one of these mortgages.