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Understanding Mortgages

What is DTI Ratio?

If you're brand new to the homebuying experience or already have some familiarity with the in's and out's of real estate, you know that this industry has a bevy of abbreviations. From FRM (fixed-rate mortgage) to FMV (fair market value) or HUD (Housing and Urban Development) to NAR (National Association of Realtors), were housing to have a favorite food, alphabet soup would likely be its dish of choice.

Here's another three-letter initialism you've probably heard of but may not know exactly what it means: DTI. Short for debt-to-income ratio, DTI is something that your lender assesses when you first apply for a mortgage. It's a mathematical equation that helps your mortgage provider determine where you are financially in terms of the ongoing costs you have now and how much of your incoming income is devoted to making payments on outstanding debt.

As you might imagine, there's a little bit more to it than that. For example, how do you calculate your DTI ratio? What's considered a "good" debt-to-income ratio? What payments are evaluated in this mathematical equation? What's the difference between back-end and front-end DTI?

You're about to find out about this and much more, which can help you better prepare for the early steps involved along the path to homeownership:

What does my DTI ratio establish and how do I figure out mine?

As previously referenced, your DTI ratio is a numerical way of identifying what percentage of your monthly salary is going toward debt. Whenever you hear this four-letter word invoked, it's often in a negative context. But debt isn't necessarily a bad thing: Virtually everyone has at least some of it in one form or another to pay for certain goods, possessions or services experienced at various stages of life. In fact, paying off debt on a regular basis helps to improve your credit standing.  

It's too much debt that's the problem. DTI ratio enables your lender to see how much - or how little - you currently have. It's calculated like this:

  • Monthly payments ÷ gross monthly income = DTI ratio

"Monthly payments" is a pretty broad term and will likely vary considerably depending on your situation and age. For instance, if you recently graduated from college, you may still have college loans to pay off or auto payments. If these are costs you currently have, they're used to determine your DTI.

Consider this example, let's say you're paying $1,000 month in student loans and around $350 for that new car you bought. That equals out to be $1,350. 

Once you divide this total by your pre-tax income - say, $4,000 per month -  and then multiplying the total by 100, you get a percentage of 37.5%.

These aren't the only two payments taken into consideration, of course. Other monthly debts evaluated - if you have them - include credit card payments or installment loans. 

It's also worth mentioning the expenses that are not included in determining your DTI. These include rent, medical bills, utility expenses, telephone and cable bills or groceries. Since these cost considerations don't appear on your credit report, they're not used for DTI ratio calculations. 

What's considered a good DTI ratio?

There aren't many absolutes when it comes to applying for a house. Because each person is different, what's considered a "good" ratio for you may be "needs work" for another. The ultimate answer depends on the circumstances of the moment, such as the house in consideration, the terms of the loan and other personal factors. 

That said, the ideal range is between 28% and 43%. Using the above example, a DTI ratio of 37.5% means that slightly more than a third of a prospective borrower's earnings are servicing debt. As noted by the Consumer Federal Protection Bureau, the debt to income ratio should ideally be no higher than 43%, as studies have shown those who devote more than this percentage of their earnings to ongoing debt frequently encounter issues with paying off their expenses. But again, when its evaluated in consultation with your other financials, certain exceptions may apply. 

What's the difference between back-end ratio and front-end ratio?

There are two ways of examining your DTI: front-end and back-end. Both are after the same goal of determining how much of your income goes to certain payments. It's the number of "ingredients," if you will, that's slightly different. The former takes into account things like credit card debt and installment loans, such as if you're making car payments or have a personal loan out.

The latter evaluates these expenses along with your prospective monthly mortgage payment. It's possible - in fact, likely - that your front-end ratio total will be different from your back-end. Neither one is necessarily more important than the other. This is just another way of examining your financial situation so your lender can get a better idea of your current situation to put you in the best position possible moving forward.

How do you go about reducing your DTI ratio?

Of course, the best type of DTI ratio is a low one. But if yours is a bit high, you may be wondering how to cut it down a bit. Here are a few creative strategies, as suggested by Credit.com. 

Prioritize your payments

Just as types of bills run the gamut, so do the ways in which you can prioritize them. For example, some financial advisors recommend paying down the one with the highest bill-to-balance ratio. Here, you concentrate, not necessarily on the total amount owed, but the degree to which you're reducing debt in combination with what your spending. That means that if one monthly payment reduces the balance by 35% and the other cuts it down by 20% or 25%, prioritize the first payment as opposed to the second.

Other experts say it's best to pay down the bill with the highest interest rate first. This strategy will save you money, as you’ll spend less on interest over time.

Then again, it may be a better choice to pay off the balance that's the smallest first, as paying it off completely provides a sense of accomplishment, giving you motivation to continue paying off debts. 

Another strategy is to pay off your credit cards first. This not only decreases your DTI, but also can help to increase your credit score if you are able to decrease your credit card debt to below 30% of the maximum available credit.

The key to success in reducing debt  is knowing what works best for you. Practicing some self-reflection will help you with prioritization. This way, you'll get the most balance-slashing bang for your bill-spending buck.  

Pay off your bills before they’re due

For installment loans like car loans, monthly statements typically feature at least three components: the monthly balance owed, how much still remains to be paid and the bill's due date. Instead of paying the prescribed amount, though, you may want to consider spending a bit more if your budget allows for it. For instance, if you earn a commission and earned a higher dollar figure than is typical, consider devoting the difference - or a portion of it - to your next monthly payment. This will help you pay the debt off ahead of schedule and potentially pay less money in interest in the process.

Ask for a raise

According to a recent poll conducted by staffing agency Robert Half, approximately 50% of full-time working adults in America believe they're underpaid. If you consider yourself one of them, consider asking for a bump in pay. As noted by Credit.com, as it pertains to DTI ratio, people often get caught up on how much they owe. But the "I" in DTI is every bit as important as D. Thus, if your monthly income is $4,000 per month before taxes and after a raise it's increased to $5,000, your DTI ratio will naturally lower, assuming that your debts remain unchanged. Actually receiving a salary increase is easier said than done, but you can state your case by demonstrating why you're an asset to your employer by pointing to previous accomplishments or contributions.

Think about refinancing

The interest rate environment is in a near constant state of flux, but one thing is certain: Rates have remained low for many years. You may want to refinance with your lender if you're still paying off student debt or a car loan. Your credit situation may have improved since you first took out the loan, which could make you eligible for a rate adjustment. 

Your DTI ratio is one portion of the mortgage approval puzzle. RMS can help you put all of the pieces together so you can see the big picture. Contact us and we'll be happy to assist you in coming up with a solution.  


Understanding Mortgages

First-time Homebuyer Loan Programs: What Are the Options?

Whether they're newly minted college graduates, settling down to start a family or simply feel like the time is right, prospective first-time homebuyers come from a variety of different situations and backgrounds. Yet given current residential real estate price trends - increasing for 89 consecutive months on a year-over-year basis, according to the National Association of Realtors - something almost all of them share in common is their need for a home loan to put toward buying a home.

If this sounds like you, good news: There are lots and lots of first-time homebuyer loan programs available. So many, in fact, keeping them all straight in your mind can be harder than decluttering your home after the holidays or a recent move.

Your mortgage lender may not help you tidy up, but they can assist with clearing things up so you know more about each program. Let's go through some of the most popular first-time homebuyer loan programs to give you a better understanding of what's available and determine what may be worth further pursuing before you obtain a real estate agent. 

What is a first-time homebuyer?

Before we get down to brass tacks, it's helpful to understand the meaning of a first-time homebuyer, because the meaning is broader than what you might think. Of course, the most basic interpretation is, someone who has never purchased residential property. The U.S. Department of Housing and Urban Development's definition is rather expansive. According to HUD, a first-time homebuyer can also mean an individual who hasn't owned a house in the last three years.

An awareness of what circumstances are indicative of first-time homeownership can give you a better idea of whether you qualify for a specific loan program. With all that said, let's talk about the options that are out there, in no particular order:

USDA Loans

One of the more popular loan programs out there is officially known as the Rural Development Guaranteed Loan Program. For the sake of brevity, they're more commonly referred to simply as USDA loans - backed by the U.S. Department of Agriculture. 

Frequently, first-time homeowners are in financial situations where they may not be making as much money as they would like, such as if they're fresh out of college or have expenses associated with raising young children. USDA loans are tailor-made for these individuals because people with low-to-moderate incomes are eligible. 

Another characteristic of USDA loans is location. In other words, in order to apply for this program, the property that you seek must be within a rural area. On the surface, this may sound like this confines you to a very limited selection of houses to buy, which when paired with the historically low rate of inventory, may seem potentially problematic. However, as statistics from the U.S. Census Bureau show, 97% of America's land area is rural. Paired with the fact that only 19% of the population live in rural locations, you should have plenty of potential properties to select from, with new and existing-home supply levels starting to improve.

FHA Loans

Another government-backed mortgage offering is an FHA loan, which was developed by the Federal Housing Administration. Similar to the USDA loan program, FHA loans offer a lot of flexibility and may even be a bit more accommodating in certain respects because you can buy a house in the suburbs or the city. Yet unlike USDA loans, a down payment is required. Nonetheless, FHA loans are still highly flexible because the down payment can be as low as 3.5%.

There are lots of advantages that come with FHA loans, but if you had to narrow them down to just one or two, they're likely the down payment and closing costs. As previously mentioned, not only do many people spend as little as 3%, but the source of the money can be a gift from a friend or family member. Closing costs, meanwhile, can be included in your loan amount, so you can pay them off over time rather than all at once as a lump sum.

VA Loans

Are you a retired or active member of the Army, Navy, Air Force, Marines, Coast Guard or National Guard Reserves? The Veterans Administration has a loan product that may be right up your alley. You may not think of VA loans as a prototypical first-time homebuyer loan program, but if you served in one of the five branches of the military and were never dishonorably discharged, you likely have veteran status. You may also be eligible if you are a surviving spouse of someone who was in the armed forces.

This status gives you certain advantages as a first-time homebuyer. Chief among them with VA is no down payment, one of the most well-known features of this mortgage product. According to the most recent statistics available from the NAR, the current median price for an existing home in the U.S. is approximately $280,000. With a 3% down payment, that's $8,400. This is a considerable amount that you don't need to pay with a VA loan.

Another major advantage of VA loans is income limits - there aren't any, which can't be said for other first-time homebuyer loan programs, like USDA and state housing programs. Applicants must, of course, be gainfully employed and earning a steady income on an ongoing basis. Participating lenders - of which there are many - will go over your W-2 forms and tax documents to get a better idea of your salary and ability to make mortgage payments each month. Then again, this is true of all loans.

Conventional 3% Down

We've talked a lot about low down payments, as many people who are unable to buy a house cite this as an obstacle, according to a report from the Urban Institute. This mortgage was made with them in mind. As its title suggests, a conventional 3% down loan program - or 97 LTV (Loan-to-Value) mortgage - is geared for people who may not have tens of thousands of dollars to put toward a down payment and was created by Fannie Mae and Freddie Mac.

An additional reason why 97 LTV mortgages are ideal for first-time homebuyers is the type of loan most often selected upon entering the housing market. Overwhelmingly, the most common is fixed-rate. There are a few reasons as to why, but first and foremost is rates are predictable. In other words, once the interest rate is locked in, it stays that way for the life of the loan. There's a sense of security that comes with this fact, given mortgage rates are quite low today compared to 10 to 20 years ago. So should rates rise in the future, as they often do, the interest paid won't change. 

All this is to say that conventional 3% mortgages are exclusive to fixed-rate mortgages. There's also a maximum loan amount that you can borrow with this mortgage type. That number is presently $484,350.

Good Neighbor Next Door

When you think of truly noble professions, what ones come to mind? Police officer is certainly one of them, teacher is another and firefighter is in the conversation as well. If you recently graduated from college and now are in any of these occupations, HUD's Good Neighbor Next Door may be an ideal loan option. Relative to other mortgage programs, this one is fairly new and was launched in order to provide more of a financial opportunity for the nation's law enforcement, emergency responders and teachers to purchase a home affordably. For the amount of work they do, teachers are among the lowest paid professionals in the country, with the average public school teacher earning around $60,500, according to the most recent statistics available from the Department of Education's National Center for Education Statistics. Many contend that those in public services don't make the type of living they ought to either, with the mean annual wage for police officers at $65,400, according to data from the Bureau of Labor Statistics. 

This is made possible by cutting the list price of certain properties in half. Go to HUD's website and type in the address of a for-sale house you're considering to see whether it's eligible. 

The caveat to this mortgage product is only firefighters, police, emergency medical technicians and teachers can apply, to purchase eligible homes located in revitalization areas through the Good Neighbor Next Door Sales program. Additionally, there aren't as many participating lenders for this program compared to some of the others mentioned.

But in addition to 50% off the listed price, the down payment is eminently affordable: just $100.  

State Housing Programs

Although America is composed of "united" states, you wouldn't know it based on the cost of living from one to the next. Home prices are a classic example. In the Midwest, the median price for a house is $226,300, based on the latest calculations from the NAR. But if you reside in the West, the cost is $408,000. That's a considerable difference.

State housing programs are designed to make homeownership feasible by reflecting and adjusting to the cost-of-living factors that make a particular state unique. These are often available through state housing agencies, who partner with participating lenders by providing payment assistance programs. This assistance can be put toward the costs of home financing. 

First-time homes often fall under the banner of "fixer-upper." Here as well, state housing program can help to reduce the costs associated with renovations. 

There are some eligibility requirements to consider, which vary from state to state. For instance, what's considered a moderate income in Virginia may be quite different in Ohio or Massachusetts. 

This is something that your lender can go over with you more in depth, if this is avenue you'd like to pursue further. 

FHA 203k Rehab

Speaking of fixer-uppers, the Federal Housing Administration designed a loan program for properties that need some restoration to get looking as good as new. It's called the 203k loan program and is a popular choice among first-time buyers hoping to buy a house at a low price. Such homes may be in a state of disrepair and need financing above and beyond the list price. These loans include both the cost of buying and "rehabbing" - hence the name - the house.

There's a lot to like about 203k loans. The down payment can be as low as 3.5%, they're loan types are both fixed and adjustable-rate and you don't necessarily need a sterling credit score (700 or higher) to be approved for one.

As far as restrictions go, the funds for the renovation work must go to a licensed general contractor. In other words, DIY'ers need not apply. A construction consultant may also be a must-have in order to gain 203k loan approval. Participating lenders for this product aren't as numerous as some of the afore-mentioned either.

That's a lot of loans. And believe it or not, this isn't an exhaustive list. What's described is a sneak peek into the product itself and some of the factors to weigh as you and your loan officer narrow down the options that are best for you.

Here are a few other points to keep in mind in your homeownership journey:

  • You'll be hard-pressed to find a lender that offers every single mortgage product that's out there these days. It just isn't feasible. Nor will you be eligible for all of them. This is meant to give you an idea of what's possible. You may find that a first-time homebuyer loan program that is not in your wheelhouse is actually quite relevant to your situation. The only way of knowing is by bringing it up to your lender. Alternatively, they may reference a loan offering if your circumstances point to it as a possibility. 
  • Oftentimes, people who are new to homeownership will talk to friends about their situation and what loan product friends chose. This can give people an inkling into whether they too will qualify. The problem with this line of thinking is every borrower is a package: each comes with distinctions that make them unique. So, if you have a credit score or income that may seem low, it doesn't necessarily mean you won't be approved. Each application is assessed in conjunction with the other materials provided when applying. In short, don't assume anything. 
  • Don't worry too much about the approval process. Look at your lender as an advocate - they want what's best for you. If you're turned down, no worries. Your lender will offer suggestions on what you need to do to get the green light. 
  • All loan programs require minimum credit scores. However, how the credit score affects the interest rate is not as sensitive with state housing loans.

For more information on first-time homeownership, contact us today. We'll guide you home. 


Mortgage Speak

Fixed-rate versus adjustable rate mortgages

Fixed-Rate Versus Adjustable-Rate Mortgages: What You Should Know 
If you like choices, entering the housing market offers plenty of them. Even though inventory isn't quite as high as in previous years, nearly 2 million existing-homes up for sale is quite a few, according to the National Association of Realtors. Architectural home styles (e.g. Victorian, American colonial, ranch, contemporary, etc.) run the gamut as do mortgage types, including FHA loans, VA loans, conventional loans and more.

As it pertains to interest rates, though, it comes down to two: fixed versus adjustable. Each has its pluses, minuses and distinctions that make it different from the other. But don't let the binary nature of these fool you; there are a variety of considerations within each that you need to be mindful of to figure out which one is the better of the two for you.

If you're in the market to buy a house and hoping to take out a loan, here is a bit more on each that can help you decide the appropriate rate for your needs.

What is a fixed-rate mortgage?
As its title implies, a fixed-rate loan (FRM) includes interest rates that remain the same. This means that no matter how long you take out a mortgage for, the rate does not change from what it was when you initially applied for the mortgage. Due to market fluctuations, interest rates are subject to change on a fairly regular basis.

What makes FRMs worthwhile?
For many years, FRMs have been the most popular form of interest among mortgage borrowers. Part of the reason for this is they are inherently predictable. Generally speaking, people are creatures of habit. They appreciate the comfort in knowing what they can expect. This is particularly true as it pertains to finances. With an FRM, they can rest comfortable knowing that regardless of the rate environment, they'll pay the same interest rate for the life of their loan.

Currently, FRMs are quite low, especially when you compare them to where they once were in the 1970s and 1980s. In the late 1970s, rates were over 10% and even higher than that throughout much of the 1980s. Today, they average around 3.49% during the first week of September 2019, according to Freddie Mac. Last year during the corresponding period, they were 4.5%.

Of course, the amount of interest borrowers pay is determined on a case-by-case basis after your lender takes a look at your finances and credit history. 

What are the potential downsides of an FRM?
The main takeaway advantage of FRMs is they remain locked in. At the same time, though, the attractive element of FRMs can also be a detriment should rates lower. In other words, because they stay the same regardless of market forces, you could wind up spending more in interest compared to someone who takes out a loan later on if interest levels slip. 

What is an adjustable-rate mortgage?
On the opposite end of the interest type spectrum are loans with adjustable rates. This means that what you wind up spending in interest for however long you take out the mortgage for, will vary, perhaps even considerably. 

Much like FRMs, adjustable-rate mortgages (ARMs) are low historically speaking. As the most recent available data from Freddie Mac shows, a 5-year Treasury-indexed hybrid ARM averaged 3.30% for the week concluding Sept. 5. That's down from 3.93% 12 months earlier. 

Again, what you spend in interest may be different depending on your situation and when you decide to enter the housing market. It may also be influenced by the loan type you select.

What makes ARMs worthwhile?
The upside of ARMs is that, generally speaking, they usually start out with a lower interest rate, according to the Consumer Financial Protection Bureau. This can make them highly appealing to first-time homebuyers, who may not have as much money as they would like fresh out of college or starting a family. According to NAR data, first-time buyers represent approximately 33% of those who are looking to buy.

The low interest rate may remain the same for several months or perhaps even years. However, once the introductory period concludes, ARM borrowers frequently wind up spending more than they did originally, CFPB noted.

Take what is known as a 5/1 ARM as a classic example, yet another loan option of many that are offered by lenders these days. These products combine FRMs and ARMs by the rate staying locked in for the first five years. Thereafter, however, the rate is subject to change with each passing year until the loan is ultimately paid off completely. 

What are the potential downsides of an ARM?
Herein lies the rub with ARMs: They're inherently unpredictable. The amount you spend in interest in one year can be notably more than you pay 12 months later. This can present financial complications depending on your work situation and how you budget your money. At the same time, though, the difference in interest may not be all that significant at all, making the ARM potentially more worthwhile from a cost savings perspective than an FRM. 

When should you choose an FRM? An ARM?
While choices are nice to have, they, at the same time can be difficult to make. Selecting between an FRM and ARM is no exception. However, there are certain scenarios in which one may be more preferable than the other. Say you're in a comfortable situation with regard to work or home life and you don't expect any major changes in the foreseeable future. There's a certain comfort in this and can make choosing an FRM a smart move, especially if the locked-in rate is something that works for your budget. In short, if it ain't broke, don't fix it. 

As for when a variable rate may be more appropriate, consider how long you intend to stay in the home you plan on buying. Is this a house you see yourself living in long-term or is it more of a starter home? Perhaps you or your spouse are in the military, which would entail having to move to another state. In either of these situations, an ARM may be more appropriate because the way in which rates adjust can enable you to pay a lower interest rate early on.

If an adjustable-rate mortgage seems like the best choice, you may want to ask a few questions of your lender to get an idea of how the ARM changes over time. Here are a few of them, as suggested by the CFPB.

How soon will the rate change?
As we previously mentioned, exactly when an ARM adjusts varies from lender to lender. Much of this is dependent on the type of ARM you have. For example, a 5/1 ARM will stay the same for a longer period than will a 3/1 ARM, specifically for five years versus three. Both of these loan products are hybrid ARMs and may come in other durations (e.g. 7/1, 10/1, 15/15, etc.).

How high will rates go when they do adjust?
This is a particularly important question to ask, because what you spend for the first several years could be notably different than those following. Your mortgage provider will be able to tell you how high they'll go under the terms of the loan contract. There will be a cap, which will prevent the monthly mortgage payment from stretching your budget beyond its limit. 

Is refinancing a possibility?
Something that many people do to get a lower interest rate is taking advantage of refinancing. If you get to a point in which an ARM no longer makes sense. You may be able to switch to a fixed-rate loan. However, as CFPB cautions, don't select an ARM with the assumption that you'll be able to refinance. Even though it may be possible for you to do, market forces - as well as your own financial situation - is subject to change, which would make refinancing a move that's not in your best interest.

At Residential Mortgage Services (RMS), we know you have lots of questions about the homebuying process. We're here to offer answers in a clear, concise manner. Whether you're seriously thinking about entering the market or just want some basic information, don't hesitate to ask. We’ll guide you home.


Helpful Tips

Here comes autumn

Here Comes Autumn:

Time to start prepping your property for winter

The first official day of Fall, September 23, is upon us. As the weather becomes crisper, it is time to start preparing your home for the winter months. Taking time to winterize your home can increase the longevity of your appliances, keep your house running efficiently, and can even save you money.

Insulation:

  • Check your window and door frames for drafts, loose frames, or cracked panes. Caulk and use weather stripping as needed. Click here for a checklist from the Department of Energy to make sure your home is sealed top to bottom.
  • Install storm panes as needed.
  • Check the insulation and wrap pipes in unheated locations.

Circulation:

  • Reverse your ceiling fans so they turn clockwise. This will draw rising air down.
  • Change your furnace filters to ensure efficiency.
  • Make sure your furniture is not directly in front of vents so the warm air can circulate.

Home Interior:

  • Clean and prep your furnace, wood stove, fireplace and back up generator.
  • Prepare an “emergency” kit in case of power outages from storms with some key items:  food, water, battery operated radio, flashlights and batteries.
  • Clean clothes dryer vent pipe.
  • Clean showerheads, bathroom drains and vents.
  • Test your smoke and carbon monoxide detectors.

Home Exterior:

  • Clean, repair and store your grill, patio furniture and pool accessories.
  • Prepare lawn mowers, leaf blowers, weed whackers and other yard maintenance equipment for storage; don’t forget to drain fuel from all gas-operated equipment.
  • Close outdoor water valves and drain garden hoses.
  • Bring your plants inside before the temperature goes below 45 degrees.
  • Clean out your gutters.

Spend some time winterizing your home this Autumn so you can stay toasty warm during the winter months.

House with blue background and snow

 


Understanding Mortgages

USDA Loans - do I qualify?

What are USDA Home Loans? Do I Qualify?

Deciding between rural and suburban is one of many choices you'll make along your homeownership journey. And if the countryside is your preference, then you may want to consider applying for a USDA loan. You've probably heard of the USDA loan program, as it's one of the more popular mortgage loans available. However, you may not know too much about the particulars, such as whether you qualify, what closing costs are like and which mortgage lenders offer them. 

You're about to learn more about all this so you can determine if this loan is right for you. 

What is a USDA-RD loan?
The USDA loan program is a mortgage offering backed by the United States Department of Agriculture. More formally known as a USDA-RD loan - the RD short for "Rural Development" - this mortgage product is geared toward families who plan on buying in a rural neighborhood. Rural home loans are designed to provide low- to moderate-income families with more of an opportunity to buy a home at an affordable price. Due in part to high demand and stretched inventory, home prices are on the rise in most locations. Indeed, according to the most recent estimates from the National Association of Realtors, the typical single-family residence in the U.S. costs around $280,800. As of July, existing-home prices have increased for 89 months in a row on a year-over-year basis.

Of course, a USDA loan doesn't reduce the cost of a property's listed price, but it can provide certain benefits that may make it a bit easier for borrowers to qualify. For example, you may be eligible for a lower down payment than you would be with a different mortgage product, perhaps even 0% down.

What are the main advantages of a USDA-RD loan?
Low or no down payment loans often get mischaracterized as mortgages that box borrowers in, leaving them with fewer options in terms of where they can buy their house or for what purposes. This certainly doesn't apply to USDA loans. They allow for a great deal of flexibility. For example, aside from buying a residence, you can also use this mortgage for refinancing or home improvement purposes. Additionally, you may be surprised by the loan amount for which you're eligible. This depends on the state you live in and how much you earn. USDA loans have fixed interest rates and are typically sold in 15-year and 30-year increments. 

Furthermore, closing costs can be arranged so that they're included in the financing or paid in full or in part by the seller. 

Another mischaracterization of rural loans is that since they only apply to rural locations, this prevents borrowers from considering houses that are in or near the city. However, what qualifies as "rural" applies to 97% of America's land area, according to the latest estimates from the U.S. Census Bureau. Translation: You likely have more options to buy outside the city than within.

Picture of a houseWhat's the difference between a USDA direct loan and USDA guaranteed loan?
As a first-time homebuyer, it's important to understand the distinctions between a USDA direct loan and USDA guaranteed loan. While they both are provided through the Department of Agriculture, they're geared toward slightly different audiences. For example, the USDA guaranteed loan is typically taken out by borrowers who earn a moderate income, while the direct loan is designed for families who make substantially less per year than what's typical in their area, or low to very low. What qualifies as "low income," "moderate" and "very low" varies, but generally speaking, low income is 50% or less of the median salary in a given area while moderate is between 50% and 80%.

Another way USDA direct and USDA guaranteed loans differ from one another is who backs or finances them. For the former, it's the USDA directly, but for the latter, private lenders provide the funding.

As you might imagine, the qualifications necessary to be approved for a USDA direct loan versus a USDA guaranteed loan are also a bit dissimilar. Take credit history. For the direct home loan program, applicants need a "reliable" FICO® score of at least 640 ("reliable" in this context means three or more trade lines in the previous two years). For the guaranteed home loan program, the "validated" credit score minimum is 640 ("validated" is defined by USDA as two or more trade lines opened in the previous year or more).   

Which one is best for you? That's something your lender can help you determine based on your needs and financial circumstances. 

Couple sitting with a loan officer

Who qualifies for a USDA loan? 
As with most things in real estate, determining whether you qualify for a USDA is a case-by-case basis. Several factors are taken into consideration. For example, the property you plan on buying must be used as a primary residence - as opposed to a vacation home - fall within an "eligible rural area" as determined by the USDA, and the owner must meet certain income requirements. It's this last factor that has several parts to it:

Location
As the old saying goes, real estate is all about location, location, location. Area influences the style of house you're likely to see and the amount of money you can expect to spend. Not only do prices in regions of the country vary considerably, USDA loans are only available for properties with rural zip codes. Because populations are always changing, what may be considered a rural area today may be different a year or two from now. This makes it difficult to determine with precision whether the property you want is in a rural part of the U.S. Once again, your lender will be able to provide the certainty you need. 

Debt to income
DTI refers to how much of your monthly earning goes toward paying expenses. The lower the percentage, the more money you have to use at your discretion. Generally speaking borrowers should have a DTI ratio no higher than 41%. There may be exceptions to this, which your mortgage lender may point out depending on your financial situation.

  

Credit history
Your credit reflects how consistent you are with making payments in a timely fashion. It's determined through your credit or FICO® score. Factors that influence your score include the amounts you owe, new credit, payment history and types of credit. USDA loans typically require a FICO® score of at least 640. Much like your DTI, your lender may have a different standard and, the credit score you need may also depend on whether you're applying for a USDA guaranteed loan or a USDA direct loan. We'll discuss this further a bit later. 

Income
You'd be hard-pressed to find two borrowers with identical incomes. Similarly, the earnings of eligible USDA loan borrowers run the gamut. The minimum or maximum income amount depends in part on whether you're taking out a direct loan or a guaranteed housing loan. If it's the latter, you may be able to earn more than what the median household income is for your area and still be eligible (up to 115%). 

Mortgage insurance
Surveys show the down payment is one of the more common barriers Americans encounter when deciding to purchase real estate, particularly among first-time buyers. Perhaps the most attractive aspect of USDA loans is the fact that you may not need a down payment to be eligible. Taking advantage of this aspect may require you to purchase mortgage insurance, though, in case of default. What you can expect to spend on mortgage insurance depends on the other aspects of your financial situation in accordance with your lender's purchase or refinancing options. 

house in an hourglass

When will you get a decision about approval? 
Now that you know a little more about some of the qualifications associated with applying for a USDA rural development loan, you may be wondering about how long you can expect to wait before an approval decision. The journey to homeownership can be summed up in three words: It's a process. Lots of factors are analyzed and documents examined (e.g. paystubs, tax returns, proof of assets, employment information, etc.). Since each individual or family's situation is different, approval timeframes can vary. However, the average period is three weeks (this could be different for each state). Part of the reason for this is the multi-step aspect to authorization. In addition to your lender, the USDA also has to sign off on it before the decision becomes final, and prior to that, there needs to be an appraisal done on the property that you seek to buy. 

There are a few things you can do, however, to speed up the process. For example, do your best to have all the information your lender asks for when they need it. This may include two years' worth of W-2 forms, tax returns, your credit report (or Social Security number so your lender can run a check) and a street address for your employer. You may also want to include the phone number of the business you work for as well.

Woman doing paperwork

You should also strive to avoid any drastic expenditures while your application package is processing. Life is literally event-full, involving milestones, memories and major purchases. But while you're awaiting a decision, put any forthcoming changes on the back burner for the time being. For example, if you're looking to buy a new car or go on an all-inclusive vacation, save that for some other day, as large purchases such as these could raise a red flag.

Finally, be reachable. There are a lot of working parts to applying for a rural development loan, and things may come up that your lender may need to talk to you about. Getting back to your lender in a timely fashion ensures that the approval process doesn't take any longer than it needs to. 

If homeownership is your aim, a USDA home loan can help you reach the target. Please contact Residential Mortgage Services - we'll guide you home. 


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