6 Common Myths About USDA Home Loans (Hint: They Aren’t Just for Farms)

In today's high-priced, unpredictable housing market, selecting the right mortgage is a make-or-break moment. Choose right, and you could save many thousands of dollars on interest, closing costs, and more.

While many mortgage options are available, one type that's often overlooked is a USDA loan from the U.S. Department of Agriculture—and it comes with a range of advantages.

Some of the top benefits? Better interest rates, reduced mortgage insurance, and options with no down payment required. 

Yet despite all these money-saving perks, USDA loans are frequently passed over because they're plagued by some persistent myths. But the truth is, you might be missing out on the best way to get yourself into a home this year. 

“It's not as scary as I think people think that it might be,” explains Jake Vehige, president of mortgage lending at Neighbors Bank. “There's not as much red tape as people think there will be.”

To help clear up the confusion, here are some of the most rampant misconceptions about USDA loans, along with some reality checks.

Myth No. 1: You have to live way out in the country to get a USDA loan

Because these loans come from the U.S. Department of Agriculture, many people mistakenly think you must buy a farm or at least live way out in the country to qualify.

“There's actually a lot of areas out there that qualify for USDA that I think people that live in them would be surprised to know themselves,” Vehige says. 

According to the Housing Assistance Council, 97% of American land is within USDA loan–eligible boundaries. Plus, many areas that aren't so far from small and midsized cities might be classified as rural areas by the USDA.

For example, Kinnelon, NJ, is an hour drive from Midtown Manhattan and even closer to many desirable neighborhoods in Northern New Jersey. This is an eligible area that might be ideal for commuters. 

Additionally, you have a plethora of options when it comes to the kind of home you can purchase. 

“You can do manufactured homes, you can do single-family residences. You can even buy townhomes and condos,” Vehige adds. 

To find out if a certain location qualifies for a USDA loan, home shoppers can use the interactive map on the agency's website. (Eligible homes are also denoted on Realtor.com® listings.)

Myth No. 2: USDA loans are only for first-time homebuyers

Another misconception is that USDA loans are only for first-time homebuyers.

“Not true at all,” Vehige explains. “We have people that definitely use it multiple times.”

The reason prospective buyers tend to believe this is because qualifying individuals must use a USDA loan for their main residence and live in it.

“It is set up in a very intentional way to help people get into primary residences,” adds Vehige.

Therefore, the home you buy can’t be a vacation home or an investment property. 

So, while the house you purchase with your USDA loan does not need to be your first, it has to be your primary residence.

If you're just looking to move from one house to another, this is definitely an option to explore.

Myth No. 3: You need a down payment to qualify for a USDA loan

Actually, one key reason to apply for a USDA loan is because, very often, no down payment is necessary.

“The purpose of the loan program is to help people in very specific areas get financing on a new home with zero money down," Vehige explains.

That said, there will be some upfront costs. 

However, when closing costs and prepaid charges (such as an earnest money deposit, also known as an escrow deposit) can be financed, Vehige says eligible costs paid upfront by the customer can be refunded, then rolled into the life of the loan.

There is one additional fee specifically associated with the USDA loan.

The USDA loan has a 1% upfront guarantee fee,” explains Vehige. “It's like a funding fee.

So, if you're buying a home for $200,000, the USDA does collect a 1% fee upfront, called a funding fee or a guarantee fee, so $200,000 is a $2,000 fee. That is rolled into your loan, so if you're purchasing a home for $200,000, it would now be $202,000.”

Myth No. 4: The insurance costs for a USDA loan are higher than regular loans

Usually when someone makes a down payment of less than 20% on a home, they are also required to carry private mortgage insurance, which guarantees the loan. 

Because people who qualify for a USDA loan often don't need a down payment, another common myth about USDA loans is that the mortgage insurance costs are high. The reality is that people with USDA loans don't need to provide PMI, because of that "guarantee fee" that is specific to USDA loans. This acts as mortgage insurance.

After the 1%, the USDA charges what amounts to .35% of your total loan balance ongoing as a monthly fee. 

“It’s basically for the USDA program to mitigate some of the default risk that any type of loan program has.”

Myth No. 5: There are no negotiations of the terms with a USDA loan

There are two main types of USDA loans: USDA direct loans, which are available only for low-income applicants and come directly from the USDA, and USDA guaranteed loans, which are offered through approved lenders that work with the USDA. The former do not have negotiable terms, but the later do.

“If you're using a USDA [guaranteed] loan, you're going to work with a loan officer, and you're going to discuss the rate,” Vehige explains. “It's no different than any other loan program in that sense. It's not a situation where you come in and they say, ‘this is what you're approved for, this is your interest rate, and there's no further discussion.’ Nope, not at all.”

With that said, be prepared for those discussions to include your credit score, interest rates that vary from what is offered by USDA direct, and potential down payment requirements. 

That’s why shopping around is a good idea, regardless of what kind of loan you’re hoping to secure. And remember, if you qualify for a USDA loan, the interest rates should always be lower than the standard industry mortgage rates. 

Myth No. 6: You must have a good credit score to secure a USDA loan

Another misconception about USDA loans is that they are only for those with good credit.

But the truth is, you can qualify for a USDA loan with less than perfect credit.

Lenders are more willing to accept a slightly lower credit score, owing to the USDA guarantee fee mentioned above. That way, if the homebuyer defaults on the loan, there is insurance in place so the lender doesn't lose the funds they've put up for the sale.

While a good credit score is always better to have (especially if you're working through a lender rather than getting a direct loan from the USDA), don't let a less-than-perfect credit score keep you from trying this route.

Additional edits and information provided by Dina Sartore-Bodo.