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How USDA Loans Saved the Market

Let’s be honest!  USDA loans can’t really save the market; however, they do have a place in today’s mortgage market.  My office has been abuzz about USDA loans for the past couple of months—a program that has become, as of October 1, the only affordable zero-down loan program available (other than VA loans, for which only veterans qualify).  USDA loans are filling the void created by the elimination of FHA seller-funded DPA (down-payment assistance) and no-down- payment conventional loans. The strange effect that we are seeing is that demand for homes outside Austin’s city limits has been affected by this loan program.

A USDA loan is geographically restrictive, and inside Austin’s city limits does not qualify. However, bedroom communities like Leander, Hutto, Kyle, Buda, and Wimberley do qualify; and borrowers who have little or no down payment are refocusing their searches in these areas.

So, what is USDA, and what makes this program better than other programs that offer a low down payment? Over the last 12-14 months we have seen a fundamental change  in (1) the way that mortgage loans are underwritten, (2) how their interest rates are set, and (3) how mortgage insurance (MI) premiums  are determined.

In the past, the rate the bank set was the same regardless of the borrower’s score—580 or 800.  Over the last few months Fannie Mae and Freddie Mac have instituted a credit score and LTV (loan-to-value) tier system for setting interest rates.  Having a 680 score rather than a 770 score will now net a higher interest rate.  Fannie and Freddie have also put into effect an LTV tier system; 90 percent LTV rates are higher than 80 percent LTV rates.

Fannie Mae, Freddie Mac, and FHA have drastically scaled back their liberal underwriting standards; and we have seen an increase in the rate of loan denials.  As  previously noted, Fannie and Freddie have eliminated their zero-down payment loans and instituted a minimum requirement of 3 percent down. FHA has eliminated the seller-funded DPA, which allowed the seller to pay for the buyer’s down payment.  They have also raised the buyer minimum from 3 percent to 3.5 percent starting January 1, 2009.

Mortgage insurance has always been that dirty little phrase in mortgage lending.  MI is insurance for the lender in case the borrower defaults on the mortgage, with the insurance covering losses based upon the coverage amount. In the past, if you were putting down 3 percent on a $225,000 home, the monthly mortgage insurance payment would be $174.60, regardless of your credit score. Since MI companies have started using a tiered premium model, that same monthly payment is now $254.25 per month.
So, what about USDA? What makes this loan better than the ones I have just discussed, and what is the downside? First of all, and probably most importantly, USDA loans are FIXED-rate mortgages with 30-year amortizations.  Most of the problems that we are seeing in the financial markets today have been caused by ARMs (adjustable-rate mortgages) and hybrid loans (loans with negative amortization).  USDA loans are fully amortized FIXED-rate mortgages, which provides for a stable payment over the life of the loan, thus giving the borrower security.

USDA loans DO NOT have a monthly MI payment!   As pointed out earlier in this article, MI payments can be a burden on the borrower in making his monthly payments; therefore, this is a huge advantage for him.  The following examples compare conventional , USDA, and FHA loans with a minimum allowed down payment, a credit score of 640, and $175,000 purchase price :

As you can see, USDA loans provide the most affordable option in financing— low payments, fixed rates, NO mortgage insurance, and little or no money out of pocket.

What is the downside of a USDA loan? USDA loans are geographically restrictive, meaning that in certain areas properties are not eligible for USDA financing. To find out which homes in Central Texas qualify, go to www.usdanow.com.  Typically, towns with a population above 25,000 do not qualify for USDA financing; however, the best place to check is this website. USDA loans are also income restrictive. Income limits are based on the total projected income for ALL adults living in the household and varies by the number of persons who will reside in the household and the location of the property. Applicants may have an income of up to 115 percent of the median income for the area. Area income limits can be found here, and I have listed the Austin/Round Rock MSA below.

As you can readily see, the income limits are fairly liberal; and a majority of borrowers can and do qualify for this program.

In the opening paragraph I mentioned that borrowers are starting to focus their attention on the bedroom communities that surround Austin.  These buyers are choosing this loan program over others, and in doing so they are adding to the demand for these communities. Not many lenders carry this program, and even fewer real estate professionals and buyers are aware of the USDA loan.   I believe that this loan program will continue to gain traction and that we will see a move towards more of these. As lending guidelines tighten and borrowers look for alternative options, this program will be in ever greater demand.  LOW PAYMENTS, FIXED RATES, NO DOWN PAYMENT, and NO MONTHLY MORTGAGE INSURANCE—this may not save the market; but it is a viable, affordable option for many borrowers

John McClellan

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