Guide To USDA Construction Loans

Video how to get a usda construction loan

If you’re looking to build a new home, a USDA construction loan could be the key to making your project a reality.

USDA construction loans can provide funds for purchasing land, plus the financing for construction costs and other necessities. All financing is wrapped into one mortgage with no down payment required.

These loans can be ideal for consolidating your financing applications and reducing your closing costs. However, you’ll have to face obstacles that don’t exist with conventional loans, including finding a USDA-approved lender.

What Is a USDA Construction Loan?

The USDA’s construction-to-permanent loans, also referred to as construction loans, are backed by the U.S. Department of Agriculture.

Borrowers can utilize program funds to purchase land in USDA-approved areas and pay for the construction or repair costs of their single-family home, eligible condo or manufactured home on the lot.

If you qualify for a USDA construction loan, you can use the funds to cover a number of important expenses that other loans might not cover, including:

  • Builder’s risk insurance
  • Closing costs
  • Construction administrative costs
  • Essential household equipment
  • Inspection fees
  • Landscaping
  • Lot purchase (any size)
  • Repairs
  • Tax and insurance escrows
  • Utility connection fees

How Does a USDA Construction Loan Work?

To acquire a USDA construction loan, you’ll first have to find a USDA-approved lender and then apply. This step can be challenging because there’s a short list to choose from. Most major lenders are not approved, including Bank of America, Citibank and Wells Fargo.

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Each USDA-approved lender has its own terms and requirements, so the USDA recommends shopping around for your loan. Regardless of which lender you choose, you can expect the following:

  • Up to 100% financing
  • No maximum purchase price
  • 30-year loan repayment (begins once construction is completed)
  • Fixed interest rate (rate is determined by the lender)
  • 1% upfront guarantee fee and a $25 technology fee
  • Annual 0.35% unpaid principal balance (UPB) fee
  • Optional interest-only payments during construction

Not only will your lender determine what USDA loan amount you can afford, but they’ll also vet and approve the builders for your construction project.

USDA Construction Loan Eligibility Requirements

  • Income. To be eligible for a USDA construction loan, you’ll have to demonstrate low to moderate income based on the median household income (MHI) in your county. You also have to use the money for building or repairing a property that will be your primary residence.
  • Debt-to-income (DTI) ratio. Your DTI ratio, including the proposed new mortgage payment, can be no more than 41% of your gross monthly income. Your DTI ratio represents how much of your income goes toward paying off debt every month.
  • Minimum credit score. The USDA has no minimum credit score requirement, but lenders have their own standards for your credit, income and debt.

Pros and Cons of USDA Construction Loans

USDA construction loans are different from conventional loans. These are the unique features you’ll want to consider before reaching out to a USDA-approved lender.

Pros of USDA Construction Loans

  • Fixed interest rate
  • Only one application for your construction financing and mortgage
  • Only pay closing costs once
  • No down payment required
  • No mortgage insurance required
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Cons of USDA Construction Loans

  • Few lenders to choose from
  • Income and location limitations
  • No interest rate cap
  • Annual fee toward the unpaid principal balance
  • Co-signers are not allowed

Alternatives to USDA Construction Loans

Going through the USDA isn’t the only way to get a loan that combines your home construction with property financing. If you’re looking for a single loan to help you buy land and build your next residence, consider these alternatives:

  • VA home loan. Eligible service members and veterans can apply for a loan with VA-approved lenders to buy land and build a home. No down payment or mortgage insurance is required, though borrowers must pay a funding fee at closing.
  • FHA manufactured home loans. FHA-approved lenders can finance up to $92,904 to purchase a manufactured (mobile) home and a developed lot.
  • Other lenders. Some lenders offer construction-to-permanent loans that aren’t backed by federal agencies. Their terms and eligibility requirements vary.

Pursuing one of these options could mean making a down payment or paying multiple closing costs. However, you could have far more lenders to choose from and more suitable requirements for approval.