A USDA loan, which is backed by the US Department of Agriculture (USDA), allows home buyers to purchase a home with no money down. USDA loans often have lower interest rates and more flexible credit score requirements than conventional loans.
Although this is affordable in many ways, know that you will have to pay what is known as a guarantee fee or funding fee, which basically acts as USDA mortgage insurance. The guarantee fee may ultimately affect whether or not a USDA loan makes sense for your financial goals. Keep reading for more information on USDA mortgage insurance and how it could impact the terms of your loan.
USDA home loans: A quick refresher
A is an affordable mortgage for people buying homes in eligible rural and suburban areas. Although the major draws of the loan include a 0% and lower interest rates, you should consider some other stipulations of the loan.
The first is a household income requirement. The income limit guidelines depend on how many people live in the house and where the home is located. Generally, your income cannot exceed 115% of the area’s median income based on your household size.
Another feature is the required USDA guarantee fee, which is essentially like mortgage insurance. We’ll break this fee down below.
What is USDA mortgage insurance?
Mortgage lenders use to mitigate the risk of loan default, which occurs when a borrower fails to make payments according to the loan’s terms. Basically, mortgage insurance protects the lender.
For , private mortgage insurance (PMI) is required when borrowers have less than 20% equity in their homes. Government-backed loans, like USDA home loans, are designed to accommodate borrowers who cannot afford larger down payments, so there is an additional guarantee fee, which essentially operates as mortgage insurance and will increase the loan cost.
Though both conventional and government-backed loans (including USDA, , and ) have a funding fee or mortgage insurance fee, there are some key differences. First, the mortgage insurance for the USDA loan is effective for the entire life of the loan. With an FHA loan, you’re eligible to remove the FHA mortgage insurance premium (MIP) after 11 years if you make a minimum 10% down payment. With a conventional loan, you can request to cancel PMI once you’ve reached at least 20% equity in your property. A VA loan funding fee is a one-time fee at closing, so you don’t have to worry about monthly mortgage insurance payments.
How does USDA mortgage insurance work?
The USDA guarantee fee or funding fee operates similarly to private mortgage insurance on a conventional loan, but the cost and structure are somewhat different.
This fee has two components: the upfront fee and the annual fee. The upfront guarantee fee is 1% of the loan amount and is payable when you . Or you may choose to roll it into the mortgage, which can minimize out-of-pocket expenses for borrowers. However, the fee gets added to your home loan principal, which you will pay interest on.
The annual fee is 0.35% of the remaining loan balance. That number is divided by 12 and included in your monthly mortgage payment.
For example, if you purchase a home for $200,000 with no down payment, you’d pay $2,000 for the upfront fee at closing (1% of $200,000 is $2,000). The annual fee is 0.35% of your remaining mortgage balance, broken down into monthly payments. At first, your monthly guarantee fee would cost around $59. As you reduce your loan balance each year, the annual payment for this fee would continue to decrease.
Can I get rid of USDA mortgage insurance?
Unlike PMI with conventional loans, you can’t stop paying for USDA mortgage insurance once you’ve reached 20% of equity in your property. You must pay the insurance premium for the life of the loan.
One way to get rid of this insurance is to out of your USDA loan and into a conventional loan — if you have at least 20% equity in your home, you can refinance into a conventional loan without getting mortgage insurance.
Though this can be a money-saving strategy for some people, it’s important to consider closing costs related to refinancing into a new loan. Also, if prevailing interest rates are higher when it’s time to refinance, refinancing might not actually save you money. These factors could negate the benefits of refinancing to eliminate the USDA mortgage insurance fees.
It’s also a good idea to factor in the insurance costs related to your USDA loan before signing on the dotted line. Even if you qualify for a USDA loan, a conventional loan could make more sense in some situations. It may take longer to save a down payment for a conventional loan, but if saving money over the life of the loan is your goal, it could be the better fit. Do the math, and talk with mortgage lenders before making your decision.
What are the pros and cons of USDA mortgage insurance?
If you are seriously considering a USDA loan, it’s important to understand how the guarantee fee plays into the total cost of ownership so you can determine if this type of mortgage is right for you.
USDA mortgage insurance pros
-
No down payment: The USDA guarantee fee allows eligible borrowers to become homeowners with 100% financing, lower interest rates, and flexible credit requirements. This makes homeownership attainable sooner rather than later, without the need to pay the higher mortgage insurance costs that come with other types of mortgages or save for a higher down payment to avoid insurance.
-
Lower mortgage insurance costs: Despite the mortgage insurance, the fees associated with USDA home loans are typically lower than those for private mortgage insurance on conventional loans and even insurance on FHA loans.
USDA mortgage insurance cons
-
Increases the cost of your loan: The USDA guarantee fee is yet another cost associated with your mortgage.
-
There are no waivers for the guarantee fee: Unlike with a VA loan, for example, there are no waivers or refunds for this fee.
-
You cannot remove the annual guarantee fee from your loan: The only way to stop paying the annual portion of the guarantee fee is to refinance out of your USDA loan.
Alternatives to USDA mortgage insurance
Here’s a quick breakdown of how the different types of mortgage insurance compare to one another.
Conventional loan PMI
is only required when a borrower has less than 20% equity in a property. If a borrower can make at least a 20% down payment, the lender will not tack PMI onto the loan. If the borrower must pay PMI, once they reach 20% equity, they can ask their lender to remove this from their monthly loan payment — regardless, the lender is required to cancel PMI when you reach 22% equity in the home. There’s no need to refinance out of the loan.
The cost will vary based on several factors, such as the amount of your down payment, the loan term, your , and your . This mortgage insurance could range from 0.50% to almost 6% of the principal amount of your loan, and it is typically paid monthly as part of your mortgage payment.
FHA loan MIP
This mortgage insurance, known as the , is slightly more expensive than the USDA guarantee fee. MIP costs 1.75% of the loan amount at closing and between 0.45% and 1.05% of the remaining loan balance annually (compared to 1% upfront and 0.35% annually for a USDA loan). But if you make at least a 10% down payment, you could cancel FHA MIP after 11 years.
VA loan funding fee
There is no mortgage insurance requirement for a VA loan, but there is a , which you can pay at closing or roll into the loan amount. This fee ranges from 1.25% to 3.30% of your loan amount, depending on your military service category, the size of the down payment, and whether this is your first time using a VA loan. It may be waived or refunded under certain conditions.
USDA mortgage insurance FAQs
Does mortgage insurance go away with a USDA loan?
No, borrowers must pay USDA mortgage insurance for the lifetime of the loan. Borrowers wishing to remove the annual premium for the USDA guarantee fee would have to refinance into a new, non-USDA loan.
How is USDA mortgage insurance calculated?
For USDA mortgage insurance, the upfront guarantee fee is 1% of the loan amount. Additionally, there is an annual fee of 0.35% of the outstanding balance, paid monthly as part of the borrower’s mortgage payment.
Do USDA loans have PMI?
No, only conventional loans have PMI. Instead, USDA loans have a guarantee fee, which is similar to mortgage insurance. You’ll pay 1% of the loan amount at closing and 0.35% annually.