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Community Development

USDA Program Opens Doors for Rural Homebuyers

Access to affordable financing has long been a barrier for lower-income rural homebuyers. Many lack the savings required for a conventional mortgage, and there are few options for down payment assistance in rural communities.
photo of people particpating in USDA homeownership program
Tammy Gilbert and her daughter held an open house to tell friends and neighbors about USDA homeownership programs in Middle Tennessee.

In addition, poor credit scores and limited access to credit counseling and homebuyer education prevent some rural homebuyers from purchasing a home.

Affordable financing options have declined nationally over the last two years as banks tightened their credit standards in response to the foreclosure crisis. For those who lack significant cash reserves or have impaired credit, few options are available. However, in rural communities throughout the Fed's Sixth District and nationwide, homeownership can still be a reality for lower-income homebuyers thanks to the U.S. Department of Agriculture (USDA)'s Rural Development Guaranteed Rural Housing Loan Program.

USDA program grows, especially in the Sixth District
Interest in the USDA Guaranteed Loan Program has intensified since 2006. The Agency's primary tool for encouraging homeownership in rural areas, the Rural Development Section 502 Homeownership Loan program, offers both direct loans and the Guaranteed Loan Program. The direct loan program has been quite effective for serving the lowest income homebuyers in rural communities, but the Guaranteed Loan Program has seen the biggest increase in funding over the past several years.

Though the nearly $7 billion in loans guaranteed by the USDA in 2008 pales in comparison to $102 billion guaranteed by the Federal Housing Administration (FHA), the volume of loans originated through the Guaranteed Loan Program nationally has more than doubled since 2006.

In the Fed's Sixth District, the program's growth has outpaced its expansion in the nation as a whole. Florida, Tennessee, Mississippi and Louisiana all rank among the top 10 states for Guaranteed Loan production. According to the Directors of Housing Programs for Rural Development in Tennessee and Florida, loan production has already doubled in fiscal year 2009 compared with the same time period in 2008, an indication that the Guaranteed Loan Program is still gaining ground. The program's recent advance seems largely attributable to the disappearance of competition from alternative mortgage financing companies.

How the Guaranteed Loan Program works
When the subprime market was in full swing, mortgage programs offered by government agencies like USDA or FHA were considered too burdensome because of loan processing requirements. Now, however, lenders and brokers are flocking to these affordable options. The Guaranteed Loan Program offers the last "No Money Down" mortgage available in rural communities, where tight credit standards, loss of financing products for credit-impaired borrowers and the absence of 100-percent financing products are thwarting many potential homebuyers.

Recent moves by Congress to ban the practice of seller-financed down payment and closing cost assistance left those lacking cash reserves with still fewer options. The Guaranteed Loan Program has not been affected by these restrictions, however, so sellers can help cover closing costs for homebuyers using this program. Homebuyers using the Guaranteed Loan Program can also roll the 2 percent guarantee fee charged by the USDA into their loan amount, so they can actually finance up to 102 percent of the appraised house value.

The fact that Private Mortgage Insurance (PMI) is not required makes the Guaranteed Loan program even more affordable. Conventional lenders including FHA typically require homebuyers to pay monthly mortgage insurance if more than 80 percent of the house price is financed. Since homebuyers using the Guaranteed Loan Program are not required to purchase PMI, their monthly housing payments are significantly lower.

Eligibility guidelines for the Guaranteed Loan Program require borrowers to have an income less than 115 percent of the county median. They must also purchase a home in a qualified rural area—generally a town or community with no more than 20,000 residents. Interestingly, however, some communities near urban centers qualify. For example, some exurban areas, such as those in central Florida that saw the most dramatic growth during the recent housing boom, are eligible for Guaranteed Loan Program financing.

guaranteed rural housing loan program production in the 6th District 2006-2008 table

Qualified private lenders underwrite the mortgages through the Guaranteed Loan Program. To assist the lenders and ensure consistent underwriting, USDA has developed the Guaranteed Underwriting System, "GUS," a software program that is available at no cost to the lender. This streamlined system makes it easier for both lenders and the USDA to operate the loan program efficiently. Tennessee was a pilot state for GUS, and currently it is used to process 80 percent of the state's Guaranteed Loan Program loan requests. As a result of the successful test-run, GUS is now being implemented in other states as well.

To further safeguard the underwriting process, all loan applications, including appraisals, are reviewed for approval by the Rural Development State Housing Programs office. Consistency in underwriting standards and review are key for ensuring the Guaranteed Loan Program's performance.

A guarantee covers up to 90 percent of the approved loan value, and USDA loans are eligible for sale to the secondary market. The secondary market for these loans is still strong due to the low risk associated with this product and the USDA's strong track record with the Guaranteed Loan Program.

Mitigating the risks of 100 percent financing
Given the well-documented problems associated with subprime mortgage products and 100 percent financing, why does the USDA continue to offer no-money-down mortgage financing, particularly to lower-income borrowers and those who appear to pose a higher credit risk? In response to these concerns, the USDA uses several strategies to mitigate the perceived risks of default by Guaranteed Loan Program borrowers.

First, the Guaranteed Loan Program has historically followed conservative, sound underwriting standards. For example, the ratio of housing cost to income cannot exceed 29 percent and the total debt ratio cannot exceed 41 percent. These ratios are more stringent than those set in many of the products that led to the mortgage crisis. In addition, interest rates for the Guaranteed Loan must be fixed for the entire 30-year term of the note. This measure eliminates the risks associated with interest-only or adjustable-rate loans.

Second, the use of the guaranteed underwriting system and centralized loan review also appear to lower delinquency rates and diminish the overall risk of the Guaranteed Loan Program. In 2008, according to the USDA, the delinquency rate for the Guaranteed Loan program was 11.4 percent and 1.4 percent of the loans went into foreclosure. While the delinquency and foreclosure rates for this program were higher than the rates for prime mortgages (6.6 percent delinquency and 1.5 percent foreclosure), the USDA program performed significantly better than subprime loans (35.1 percent delinquency and 9.8 percent foreclosure), according to Lender Processing Services Inc. Applied Analytics data for the same period.

Finally, lenders participating in the Guaranteed Loan Program receive obligatory training and ongoing assistance from USDA.

While USDA's underwriting criteria should help mitigate the risk of default associated with the Guaranteed Loan Program, questions persist about offering a 100 percent mortgage product in certain areas. In most rural communities, where housing prices are relatively stable, 100 percent mortgage financing can make it possible for lower-income individuals to build wealth through homeownership if there is even slight appreciation in their home value. However in many communities, including some now eligible for the Guaranteed Loan Program, housing prices have not yet stabilized and could still decline. Homebuyers in these communities who acquire a 100 percent mortgage still run the risk of finding they owe more than the value of the home, thus forfeiting the wealth-building and tax benefits of homeownership. Homebuyers and lenders will have to consider carefully the market conditions and the potential risks associated with a 100 percent mortgage product in certain markets.

Current and future prospects forthe Guaranteed Loan Program
The Guaranteed Loan Program is attracting some new partners in addition to continuing to serve its core mission of expanding homeownership in rural communities. For instance, in central Florida, builders and realtors have started using the USDA program to market excess housing inventory in overbuilt exurban communities. Recent changes in the USDA income qualification guidelines are expanding the program's reach to include higher-income families who might be likely to purchase homes in these communities. Some speculate that the availability of USDA mortgages in these areas may accelerate their recovery from the recent housing downturn.

Though more debate is likely about whether the USDA program should continue to provide such flexible financing, Tennessee's Rural Development Housing Program Director, Don Harris, doesn't anticipate significant changes to the core program. He points to the Guaranteed Loan Program's proven track record, its strong lending partners and its success in fulfilling the goal of providing affordable financing options for homebuyers in rural communities. "For some families, the no-money-down component of the Guaranteed Loan Program is the difference that allows them to successfully purchase a home," according to Mr. Harris. "The Guaranteed Loan Program is an example of the type of program that should be considered by lenders who want to promote responsible affordable housing opportunities in their rural communities."

This article was written by Jessica LeVeen Farr, senior regional community development manager in the Atlanta Fed's Nashville Branch.