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Understanding USDA Construction Loans

Erin Gobler6-minute read

August 30, 2021

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Homeownership is the ultimate dream for many Americans, but traditional loan requirements often make it difficult to achieve. A USDA construction loan is a way for home 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 of the requirements before you get started. It’s important to note that Rocket Mortgage® does not offer USDA loans or USDA construction loans.

What Is A USDA Construction Loan?

A USDA construction loan is a mortgage that is guaranteed by the U.S. Department of Agriculture. The program is designed to make housing accessible and affordable in rural areas. Like 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 the no down payment requirement. However, buyers may struggle to find a lender to service this type of loan.

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How Do You Qualify For A USDA New Construction Loan?

Government-backed loans such as USDA and FHA loans often have more requirements than conventional mortgages. The USDA construction loan is no exception. There’s a long list of requirements borrowers must meet to qualify for this type of loan. Here are the USDA construction loan requirements:

  • Property must in a USDA-approved area
  • Property must be the primary residence
  • USDA-approved contractor
  • New construction warranty from the builder
  • A minimum credit score of 640
  • A debt-to-income ratio of no more than 41%
  • Cannot exceed the state’s USDA income limit
  • Not experienced bankruptcy for at least 2 years

How Do USDA Construction Loans Work?

Most often, construction loans require that borrowers take out two separate loans. First, they borrow a construction loan to finance the build. Once the construction is complete, they close on their mortgage.

But 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 the building is complete, you’re left with a 30-year fixed-rate USDA loan.

What Do USDA Construction Loans Cover?

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 do they cover single-family homes, but they may also cover some condos and manufactured homes.

The construction loan covers expenses such as:

  • Buying the plot of land
  • Inspection fees
  • Builder’s insurance
  • Construction administrative fees
  • Permits
  • Design plans
  • Landscaping costs
  • Building costs
  • Utility and septic costs

The Pros And Cons Of USDA Construction Loans

USDA loans help to make rural housing more affordable and accessible. But there are several benefits and drawbacks to USDA construction loans, and it’s important to weigh these factors when deciding whether or not to apply for this type of loan.

The Pros Of A USDA Construction Loan

USDA construction loans come with a variety of benefits. First, while typical USDA loans allow borrowers to purchase an existing home, a USDA construction loan allows borrowers to start from scratch, allowing them to get exactly what they need in a home.

Another benefit of a USDA construction loan is that, unlike traditional construction loans, they take out just one loan for the land, construction, and finished home. This saves the borrower money because they only pay closing costs once. Borrowers also aren’t required to make payments during the building process, allowing them to save money.

Finally, the single close loan ensures that borrowers only have to qualify for one loan and that an unexpected change in their finances doesn’t hurt their prospects of closing on the second loan. 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 loan. Because they’ve already closed, they don’t have to worry about it.

The Cons Of A USDA Construction Loan

USDA construction loans can be an excellent opportunity, but it’s also important to understand the downsides. First, these loans may cost more in the long run than other types of mortgages. While there’s no down payment requirement, borrowers will pay PMI.

USDA construction loans also often carry a higher interest rate than other loan products. Luckily, borrowers may be able to lower that interest rate over time, such as a USDA streamline refinance.

Another downside of this type of loan is that borrowers may have a difficult time finding a USDA construction loan lender. While the loans are backed by the USDA, they’re underwritten by a traditional financial institution. However, not all lenders offer this type of loan.

What Are Alternative Options To USDA Construction Loans?

USDA construction loans are an excellent way for rural buyers to find their dream homes. But there are several other loan options for building a house, which may be easier to find than USDA construction loans. Buyers should consider how these options fit their budget and needs.

USDA Loan

Rather than taking advantage of the USDA single-close construction loan, buyers could use a land loan or construction loan upfront and then combine that with a traditional USDA loan. Because these loans are still backed by the USDA, they come with many of the same requirements.

VA One-Time Close Construction Loan

Like the USDA construction loan, the U.S. Department of Veterans Affairs also guarantees home loans. You may be eligible for a VA construction loan if you’re a current or former military service member who meets the VA’s loan requirements. Like the USDA loans, a VA loan doesn’t require a down payment. But it has the extra benefit of not requiring PMI.

FHA One-Time Close Construction Loan

An FHA one-time construction loan is a type of home loan that’s backed by the Federal Housing Administration. FHA loans are designed to help moderate-income borrowers with below-average credit scores buy homes.

There are similarities between FHA and USDA loans — both allow for a single close and a construction-to-permanent loan. But unlike USDA and VA loans, FHA loans require a 3.5% down payment (or 10% for those with credit below 580).

Conventional One-Time Close Construction Loan

Borrowers who don’t qualify for a government loan might consider a conventional one-time close construction loan. Conventional loans vs USDA loans come with a different set of requirements — you generally need better credit and a more favorite debt-to-income ratio. They also require a down payment of at least 3.5%.

But conventional construction loans also come with benefits. Often there are fewer requirements, meaning buyers have more flexibility when choosing or building a home.

How Do I Apply For A USDA Construction Loan?

Are you considering applying for a USDA construction loan? Here are the steps you’ll have to follow to qualify for your loan.

1. Find A USDA-Approved Contractor

Buyers must have an agreement with a USDA-approved contractor before they can qualify for a loan. Contractor requirements include:

  • Minimum of 2 years of experience building single-family homes
  • Pass a background check
  • Minimum of $500,000 in commercial liability insurance
  • Satisfactory credit history
  • Construction or contractor license

2. Contact Loan Lender For Preapproval

Once you have your contractor agreement in place, you can start working with lenders to get preapproved for your loan. Keep in mind that you can’t just use any lender — it must be a lender that’s a part of the USDA loan program. To get pre-approved, you’ll need to provide information such as your income and employment verification, list of assets and liabilities, debt-to-income ratio, and a credit check.

3. Send In Your Application

Once you’ve compiled all of the necessary information, you can send in your application. Make sure you verify your contractor and property location before submitting your application since both are necessary to qualify. Depending on your situation, it could take anywhere from 30 – 60 days to complete the loan process.

The Bottom Line: Build The Rural Home Of Your Dreams

The USDA loan program makes rural homeownership more affordable and accessible. And when you use a USDA construction loan, you have the opportunity to build your dream home with attainable loan requirements. USDA construction loans are just one of many options, so make sure to research the alternatives and find the loan that best fits your financial situation.

Explore how Rocket Mortgage can help you find the best loan option for your situation. While Rocket Mortgage doesn’t offer USDA construction loans, we can help you identify which loan is best for you.

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Erin Gobler

The Rocket Mortgage Learning Center is dedicated to bringing you articles on home buying, loan types, mortgage basics and refinancing. We also offer calculators to determine home affordability, home equity, monthly mortgage payments and the benefit of refinancing. No matter where you are in the home buying and financing process, Rocket Mortgage has the articles and resources you can rely on.