Homeownership is the ultimate dream for many Americans, but traditional loan requirements can make this dream difficult to achieve for some people. A USDA construction loan – sometimes known as a USDA building loan – is a way for buyers to build their dream home with a mortgage backed by the U.S. Department of Agriculture. These loans come with plenty of benefits, but it’s essential to understand all requirements before you get started.
The USDA mortgage program is designed to make housing accessible and affordable in rural areas. As with a traditional USDA loan , home buyers borrow from a traditional lender, and the USDA backs the loan. The difference between the two is that while a typical USDA loan allows a borrower to buy an existing home, a USDA construction loan allows borrowers to finance a home build.
The USDA has simplified the financing process through its Single-Family Housing Guaranteed Loan Program , which allows for construction-to-permanent loans. Rather than needing separate loans for the construction and the home itself, buyers can utilize a single close loan.
These loans come with plenty of perks, such as a no down payment requirement. However, buyers may struggle to find a lender that offers this type of loan.
Government-backed loans such as USDA and Federal Housing Administration (FHA) loans sometimes have more eligibility requirements than conventional mortgages. The USDA construction loan would fall into that category.
Here are the USDA construction loan requirements for borrowers:
As a non-conforming loan , a house built with a USDA construction loan isn’t subject to the traditional home purchasing standards of government-sponsored enterprises like Fannie Mae and Freddie Mac . However, homes built with a USDA construction loan do have the following requirements:
Most often, construction loans require that borrowers take out two separate loans. First, they may borrow a construction loan to finance the build. Once the construction is complete, they would close on their mortgage.
The USDA construction loan simplifies that process through a construction-to-permanent loan, also known as a single close loan.
The process combines a construction loan and a traditional USDA mortgage into a single loan. Borrowers have just one mortgage closing before construction begins. As a result, they also have just one promissory note and one set of closing costs. Once construction is complete, you’re left with a 30-year fixed-rate USDA loan.
USDA construction loans offer up to 100% financing, meaning they cover everything associated with the home build, and buyers aren’t required to come up with a down payment. Not only can they be used for single-family homes, but they may also be used to build some condos and manufactured homes .
The construction loan covers expenses such as:
USDA construction loans help make rural housing more affordable and accessible but come with several benefits and drawbacks. It’s important to weigh these factors when deciding whether to apply for this type of financing.
USDA construction loans carry a variety of benefits that make them a popular option for borrowers who qualify. Next, we’ll look at a few of the benefits you can expect.
They Allow You To Build Your Dream Home
While typical USDA loans allow borrowers to purchase an existing home, a USDA construction loan can let borrowers start from scratch, allowing them to get exactly what they need in a home. You’re in control of the features, size and location of your home and can truly make it the home of your dreams.
They Streamline The Financing Experience
Unlike with traditional construction loans, borrowers using a USDA construction loan take out just one loan for the land, construction and finished home. This saves the borrower money because they only pay closing costs on a single loan. Borrowers also aren’t required to make payments during the building process, freeing up cash each month to help them cover rent and other living expenses until they can move into their new home.
They Give Borrowers Peace Of Mind
The single close loan ensures that borrowers only have to qualify for one loan and that an unexpected change in finances won’t hurt their prospects of closing on their mortgage. Imagine that, after closing on the construction loan, a change to the borrower’s credit score meant they would no longer qualify for their 30-year mortgage. Because they’ve already closed on a USDA construction loan, they don’t have to worry about losing out.
USDA construction loans can be an excellent opportunity, but it’s also important to understand the downsides, which we’ll examine below.
They Come With Higher Costs
These loans may cost more in the long run than other types of mortgages . While no down payment is required, borrowers will pay upfront and monthly guarantee fees . The upfront fee will cost borrowers 1% of the loan amount, and the annual fee (broken down into monthly payments) will cost 0.35% of the remaining loan amount. That can add thousands of dollars to your total closing costs and hundreds of dollars to your monthly mortgage payment.
They Have Higher Interest Rates
USDA construction loans also often carry a higher interest rate than other loan products. The higher rates mean you may end up with a higher mortgage payment than you’d have if you financed the build with a different type of construction loan. Luckily, borrowers may be able to lower that interest rate over time with a USDA Streamline Refinance .
They’re Not Issued By All Lenders
Another downside of this type of loan is that some borrowers may have a difficult time finding a USDA construction loan lender. While the loans are backed by the USDA, they’re underwritten by traditional financial institutions. However, not all lenders offer this type of loan. The best action you can take is to speak with your lender about your options.