If you want to own land and build your own home, a USDA construction loan might seem ideal.
A USDA construction loan can finance the land, build your home, and serve as your long-term mortgage — essentially rolling three loans into one. Plus, there’s no down payment required and only one set of closing costs.
However, these loans can be hard to find. And you need to be an eligible borrower building in an eligible rural area. Finding a lender could be challenging, too.
Read on to learn more about USDA construction loan rules and rates, and other loan types that could potentially be a better option.
In this article (Skip to…)
A USDA construction loan can be an affordable way to buy land and build a home. It combines financing for the land, construction, and a fixed-rate mortgage into one loan product.
This program, which is backed by the U.S. Department of Agriculture, can also be referred to as a:
There are some serious benefits to a USDA construction loan if you qualify; no down payment is required, mortgage insurance is affordable, and USDA rates are typically low.
However, USDA construction loans are pretty rare; you may be hard-pressed to find a lender offering one. And USDA has strict requirements for the home buyer and the property being built.
With all these restrictions, some borrowers will find other types of construction loans to be an easier path to homeownership. But for the right person, a USDA construction loan could be ideal.
The important thing is to explore all your options and find the right loan product for you.
Brandon Mushlin with BuildBuyRefi.com explains that a USDA construction loan makes it easy for an eligible borrower to acquire land, have a new home built, and finance that finished home over up to 30 years — all in one simple loan.
You only have to pay for closing costs once, since a single closing is involved, and only one qualification and one appraisal are required.
“You can either find land to place under contract, use current land you already own, or use land deeded over to you from family to combine with your chosen and approved builder to construct your home,” he says.
According to USDA, funds can be used to build and purchase single-family homes, including eligible condos and manufactured homes.
The loan amount covers:
Like other loans backed by the U.S. Department of Agriculture, the USDA construction loan offers up to 100 percent financing. That means qualifying borrowers don’t have to make a down payment.
In addition, you aren’t obligated to make payments while the home is being constructed.
On the downside, these loans are difficult to find and rarely offered by lenders, according to Richie Duncan, senior loan officer with Nationwide Home Loans Group, a division of Magnolia Bank.
“USDA construction loans require patience on the part of everyone involved. They take longer to close, could involve Realtors, insurance agents, city or county permitting requirements, builder approval, multiple underwrites of your credit file, appraisals, and more,” Duncan notes.
“And the interest rate you’ll be charged will likely be higher than for normal purchase and refinance loans on existing homes.”
However, you might not be stuck with that higher interest rate forever.
After your home is built (at least 220 days later) and after making six on-time payments, if market conditions allow “you can opt for a streamline refinance or rate-and-term refinance to lower your interest rate, if possible,” adds Duncan.
While there are many requirements and restrictions involved, “once obtained, this is one of the best loans for a borrower to build their dream home with little to zero paid out-of-pocket,” says Duncan.
“As a result, you can save your liquidity, increase your landholdings, and avoid the higher 10 to 25 percent down payment requirements that other traditional lenders may stipulate with more associated risks.”
A USDA construction loan allows you to purchase both the land and the home. But some restrictions apply.
First, the land must be in a USDA-approved location. These areas must be “rural in character,” though many small towns and suburbs qualify.
“Also, this is not a loan that you can use to purchase land now and build on at a later time. Once you close on the loan, you are expected to start building when given the green light, which is usually quickly,” says Duncan.
If you want to purchase land first while you are shopping for builders, this is allowed. You can take out a loan elsewhere to buy the land, and then a USDA construction loan lender can include the payoff of that land balance in your new loan.
“If you pay cash or already own the land free and clear, you cannot get cash back or be paid back. That would involve a cash-out loan, which is not allowed in any version of a USDA loan,” Mushlin cautions.
Note that it’s not necessarily easier to get a USDA construction loan if you already own the land. Although, it might be easier to get another type of new construction loan.
“Having your land paid off or owned outright will reduce your loan-to-value ratio, which means you won’t need 100 percent financing,” Duncan continues.
“This increases your possible equity position and will lower your payment further than a borrower who is purchasing new land or paying full price for the land.”
Mushlin and Duncan point out that several rules are attached to USDA construction loans.
Eligibility requirements include:
Your lender will also look for 12 to 24 months of clean, unblemished credit, no gaps in your income, no mortgage forbearance, and no late or missing rent payments.
“Basically, you want to have the cleanest credit, income, and debt ratio possible to get this loan,” suggests Mushlin.
In addition, the new home must be your primary residence, meaning you’ll live there full-time. And the types of homes eligible to be built are limited to single-family homes, manufactured homes, and eligible condominiums.
“Second or vacation homes, homes intended to be used for short-term or long-term rentals, accessory dwelling units, self-built homes, commercial buildings, and mixed-use construction are not eligible,” adds Duncan
Although there are big potential benefits to a USDA construction loan, it can be difficult to find lenders offering them in practice.
“Even the largest of lenders don’t offer this program for many reasons. These include factors like longer closing time, higher risk to underwriting and investors, having to lock the rate longer, and needing to communicate with many moving parts over a long period,” Duncan says.
An online search for ‘USDA construction loan lenders’ should yield some lenders you can investigate.
“I recommend choosing a lender that knows exactly what this process involves and has closed these loans before. You want someone transparent, upfront, and who doesn’t sugarcoat or gloss over the details of what you’re looking for,” advises Mushlin.
As mentioned earlier, the interest rate you may be quoted on a USDA construction loan will likely be higher than rates offered for a separate lot loan, construction loan, and 30-year mortgage loan.
“Rates are difficult to compare among the lenders, investors, and brokers offering this loan,” says Duncan.
“Every loan is priced uniquely based on individual factors, fees, and margins. You may also be able to buy down your rate, which could become a factor when trying to qualify at a certain debt ratio with higher payments.”
As always, you should shop with a few different lenders to find the best rate available to you.
If you can’t find multiple USDA construction loan lenders to compare, try expanding your search to include other types of construction loans.
By looking at rates for alternative construction loan programs (see below), you can at least get a feel for how competitive a USDA construction loan is and whether it’s really your best option.
Here are a few other construction loan options to consider if you’re having trouble finding USDA loans, or simply want to widen your search:
The right type of construction loan depends on your location, home building budget, credit score, and down payment, among other factors.
You should make sure you’ve explored all your options and found the best loan for you before signing on.
Yes. The USDA offers a combination construction-to-permanent loan, also called a single close loan. This loan combines financing for the lot, new construction, and a fixed-rate mortgage into a single loan.
Yes. The USDA Rural Housing Site Loan can be used to purchase land on which you’ll construct a single-family home. USDA land loans are only available to low- and moderate-income families. The maximum amount of allowable income is 115% of the borrower’s area median income (AMI).
Richie Duncan with Magnolia Bank explains that a USDA construction loan offers 100 percent financing, with no down payment required, so long as you are well-qualified for credit and meet income and other requirements.
Duncan says it’s neither easier nor more difficult. But owning your land outright can reduce your loan-to-value ratio, which means you won’t need full 100 percent financing.
If you have an outstanding lot loan, that loan will need to be paid off and rolled into your new USDA construction loan, per Duncan.
A USDA construction loan can only be used to finance single-family homes, manufactured homes, and eligible condominiums. Vacation or second homes, short-term and long-term rental properties, accessory dwelling units, a home you build yourself, commercial buildings, and mixed-use construction do not qualify for USDA financing. In addition, the lot must be in a USDA-eligible ‘rural’ area.
Most lenders require a minimum FICO credit score of 640 to qualify for a USDA construction loan.
A USDA construction loan typically converts to a 30-year fixed-rate mortgage. At least 220 days after construction has completed and after you’ve made six on-time payments, you may be able to lower your interest rate by refinancing via the USDA Streamline Refinance or another refi program.
You can apply for a USDA construction loan with USDA-approved lenders who offer this loan program. Search online for available lenders.
A USDA construction loan can be an attractive and affordable option for buying land and building a home. But these hard-to-find loans aren’t available to everyone.
Luckily, there are plenty of other construction loan programs on the market.
Explore the different types of construction loans available, then talk to lenders about which program can best meet your needs.
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
© Copyright Full Beaker, Inc. 2022