Are USDA loans possible? Yes, and here’s how to do it

Interest rates have started to fall from recent highs, but remain above 6% for most borrowers. So how do some buyers get into rural properties with mortgages as low as 4% or even lower? One method is to find homes that qualify for USDA loan foreclosure.

Key takeaways

• Assuming a mortgage allows you to take over an existing loan and keep the interest rate and terms intact.

• USDA loans can be assumed, but not all lenders are willing to offer loan assumptions.

• To get a mortgage loan, you still need to meet USDA and lender requirements.

• Assuming a low-interest loan can lower your monthly mortgage costs and lower interest rates over your lifetime.

Are USDA loans possible?

First, let’s get the most important question out of the way: Are USDA loans achievable? The answer is yes, you can take out USDA loans. But what exactly does this mean?

Taking out a mortgage loan allows you to take over an existing loan with its current interest rate and terms. In most cases, only the person responsible for making the payment changes.

Since most homeowners are stuck with lower interest rates than those currently available in the market, assuming an existing USDA loan can save borrowers significantly on their monthly repayments. Plus, closing costs are lower because you’re not taking out a completely new mortgage.

However, not all USDA lenders allow mortgage foreclosures. In addition to finding a seller with a USDA loan, you also need to verify whether their mortgage holder would even consider doing so.

Then you also need to calculate the difference between the seller’s loan balance and the contract price of the home.

However, buyers who understand and are prepared for the USDA loan foreclosure process can save significantly by assuming the seller’s current low-interest mortgage.

Do I qualify for a USDA loan?

Assuming a USDA loan requires meeting all standard USDA and lender eligibility requirements. The qualification process is the same as applying for a new loan and includes a full loan and income guarantee.

Note: There are some rare cases, usually involving an inheritance or court-ordered transfer of property, in which you may not be required to qualify for a USDA mortgage loan.

Residency requirements

For USDA loans, you must plan to occupy your home as a permanent residence within 60 days of closing.

Income limits

You cannot earn more than 115% of the median household income in your purchasing area.

Credit score

The USDA does not set a required score for its loan program, but each lender will have its own minimum credit standards. Mortgage companies often look for a score of 640 or higher for USDA loans. Still, some lenders will approve buyers with worse credit through manual underwriting.

Debt to income ratio

Your debt-to-income ratio (DTI) is the percentage of your monthly earnings that goes toward paying off debts, including your mortgage. Most USDA lenders have a maximum DTI limit between 41% and 44%.

Employment history

Lenders typically want two full years of employment history with stable and steady earnings. However, in some scenarios, applicants with an employment gap may still be approved.

How to Set Up a USDA Loan

1. Find a property with a possible USDA loan

Not all homes listed for sale will have a loan available, much less USDA insured. Even then, not all USDA lenders allow loan assumptions. Fortunately, more listing platforms have emerged that allow users to filter properties by those with possible loans.

2. Negotiate the sales price and determine how to cover the gap between it and the loan balance

When you buy a home and take out an existing mortgage, the loan balance will likely be less than the current value of the property. For example, a $300,000 home with a $250,000 mortgage would require the buyer to come up with $50,000 in cash or on a second loan.

3. Submit a foreclosure request to your lender

Once you have your home under contract, you can submit an application to your lender to begin the loan foreclosure process.

4. Provide the necessary documents typically required from all borrowers

Like most other mortgage loans (except for some streamlined refinances), establishing an existing loan requires the submission of documents such as W-2s, filed tax returns, and bank and property statements. Some lenders simplify this process by using direct verification.

5. Wait for the lender to complete the underwriting process

The lender will then comb through all of your documents and make sure you are fully qualified to get a USDA mortgage loan. Expect underwriting to take a little longer than with a standard purchase loan.

6. Sign USDA loan establishment documents, pay closing costs and finalize your home purchase

Once your lender has approved your foreclosure on your existing USDA mortgage, the final step is to close on the property. You’ll sign the USDA loan establishment papers, pay the seller closing costs and the balance, and then walk away with the keys to your new home.

Advantages of assuming a USDA loan

A possible USDA loan can benefit both buyers and sellers, offering a win-win situation in today’s difficult housing market.

Benefits for Buyers

• Lower interest rates – Rates are much higher than they were just a few years ago, which has a direct impact on housing affordability. Assuming a USDA loan allows you to take over your existing mortgage loan with a below-market interest rate and lower payments compared to a brand new loan.

• Lower interest over your lifetime – Reduced interest rates don’t just lower your monthly payments; they also lower interest costs over your lifetime. For example, a $200,000 home loan at 6.5% interest would earn $255,000 in interest over a 30-year repayment period. Assuming a 3.5% mortgage, your lifetime interest cost would be just over $123,000.

• Cheaper closing costs – To take out a USDA loan, you still have to pay some closing costs, but the total is likely much less than if you took out a new mortgage. Avoiding the USDA upfront guarantee saves you 1% right off the bat. Plus, you won’t have to get a new quote, which can reduce costs by $500 or even more in most locations.

Benefits for sellers

• More tradable properties – Offering a possible loan at a lower interest rate than buyers could currently get is a major selling point, especially in the current housing market. This increased affordability allows you to reach a wider range of qualified buyers.

• Potential for a higher selling price – A USDA mortgage loan can often achieve a higher sales price than comparable homes with non-marketable loans due to buyers’ willingness to pay the premium for lower monthly costs.

• Savings on sales fees – Homeowners with repayable loans often consider offering their property to friends or family members to help reduce housing costs. Doing so can also benefit the seller by eliminating the 5% to 6% commission typically paid when listing through a real estate agent.

Disadvantages of Assuming a USDA Loan

While assuming a USDA loan can offer many benefits, there are some drawbacks that should be considered before limiting your home search to possible mortgages.

Fewer houses to choose from

Although it is more common in some areas than others, most homes for sale do not have USDA mortgages. Data from the Mortgage Bankers Association show that USDA loans account for less than 0.5% of all new mortgage applications.

May require cash deposit

If the seller has equity in the home, you will likely need to cover the difference between the assumed USDA loan balance and the sales price with a cash down payment. It is possible to apply for a second loan, although closing costs and higher interest rates may reduce the benefits of taking out a mortgage loan.

Not all lenders accept the assumptions

Although USDA guidelines allow foreclosures on agency-guaranteed mortgage loans, individual lenders have the right to deny foreclosure requests. In some cases, lenders may not allow assumptions at all, while others may only allow them in certain circumstances.

Getting a mortgage loan may take longer

Assuming a mortgage loan often takes longer than getting a new loan. Although the reasons vary, lenders often place less priority on meeting the loan’s objectives than on originating new mortgage loans that generate more revenue for the company.

Alternatives to USDA Loan Foreclosure

USDA loans aren’t the only types of mortgages available. While conventional loans are not available for borrowing, all government-backed loans are. In addition to the USDA, you can also take out a mortgage issued by the FHA or VA.

Establishing an FHA loan

FHA loans are much more common than USDA-backed ones, accounting for about 15% of all applications. FHA-backed mortgages do not have income and geographic restrictions like USDA-backed mortgages and can generally be considered by borrowers with a credit score of 580 or higher.

VA Loan Establishment

VA-backed loans are possible, but many sellers are willing to transfer mortgage loans only to other VA-eligible borrowers. Ineligible buyers (who still meet other VA and lender guidelines) can take out a VA loan, but the seller’s “loan eligibility” will remain limited on the home, preventing them from reaping the full benefits in the future.

Conclusion

Taking out a USDA loan can allow buyers to stretch their purchasing budgets even further by acquiring low-interest mortgage loans from sellers who benefit from the competitive advantage of having a home loan option.

However, assuming a USDA loan can take longer than getting a regular mortgage, and some lenders may not even allow assumptions at all.

If you’re having trouble finding a foreclosure mortgage or a foreclosure-eligible loan, consider applying with a conventional or FHA lender. Both options have guidelines that differ from USDA guidelines, and mortgage providers may agree to purchase a wider range of homes.