USDA Construction Loan to Buy Land

Buy land and build a home with a USDA construction loan

If you want to own land and build your own home, a USDA construction loan might seem ideal. USDA construction loans can finance the land, build your home, and serve as your long-term mortgage. They essentially roll 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 a qualified rural area. Read on to learn more about USDA construction loan rules, rates, and other loan types alternatives.

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What is a USDA construction loan?

A USDA construction loan is a mortgage that allows borrowers to buy land and build a home all with one loan and monthly payment. This program, which the U.S. Department of Agriculture backs, is similar to a standard USDA loan. The big difference is that USDA construction loans combine financing for the land, construction, and a fixed-rate mortgage into a single loan product.

USDA construction loans offer some serious benefits. Qualified borrowers will enjoy:

• No down payment requirement
• Affordable mortgage insurance
• Below-market USDA rates

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.

How do USDA construction loans work?

USDA construction loans work by offering simplified financing through its Single-Family Housing Guaranteed Loan Program. So rather than obtaining separate loans to buy land and pay for construction costs, borrowers can use a single loan to pay for everything.

The loan amount covers:

• Buying a lot
• Reasonable construction administrative costs
• Contingency reserves
• Inspection fees
• Builder’s risk insurance
• Landscaping costs
• Other authorized items

According to USDA, funds can be used to build and purchase single-family homes, including eligible condos and manufactured homes.

USDA construction loans can also be referred to as a:

• One-time close construction loan
• Single-close loan
• Combination construction-to-permanent loan
• All-in-one construction loan

Can you buy land with a USDA construction loan?

A USDA construction loan allows you to purchase both the land and the home. But some restrictions apply. For example, 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 Richie Duncan, senior loan officer with Nationwide Home Loans Group.

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,” cautions Brandon Mushlin with BuildBuyRefi.com.

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 purchasing new land or paying full price for the land.”

USDA construction loan requirements

Government-backed mortgage programs often come with numerous requirements that both the property and borrower must meet. USDA construction loans are no different. In fact, because of the complexity of this land loan, qualifying can be challenging for many potential borrowers.

​Eligibility requirements for a USDA construction loan include:

• Most lenders require a 640 minimum credit score
• A debt-to-income ratio of no more than 41%
• You must not have experienced bankruptcy in the last two years
• You cannot exceed USDA income limits based on your area’s median income and the size of your family. The USDA Rural Development program is intended to help moderate- and low-income families purchase and build homes
• The property must be located in a USDA-approved area
• You must receive a new construction warranty from the builder
• Any remaining funds after construction ends must be applied directly toward your loan principal
• The USDA must approve of your chosen contractors, who are required to have needed licensure, liability insurance, and a minimum of two years’ of experience building homes

Your lender will also look for 12 to 24 months of clean, unblemished credit history, 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-to-income 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

Pros and cons of USDA construction loans

USDA loans are designed to help moderate- and low-income Americans become homeowners. They do this by offering affordable financing for real estate in designated rural areas. Still, it’s important to understand the pros and cons of the USDA construction loan to make the best decision for your financial situation.

Pros of USDA construction loan

The biggest benefit of USDA construction loans is that you can buy land, build a new home, and finance that finished home over 30 years — all in one simple loan.

“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,” explains Mushlin.

• One loan and one mortgage payment: Simplified financing to build a house and buy land
• One round of closing costs: You only have to pay for closing costs once, since a single closing is involved, and only one qualification and one appraisal are required
• No down payment requirement: Like other loans backed by the U.S. Department of Agriculture, the USDA construction loan offers up to 100% financing. That means qualifying borrowers don’t have to make a down payment
• Deferred repayment: You aren’t obligated to make monthly payments while the home is being constructed

Cons of USDA construction loans

The biggest drawback to USDA construction loans is they can be difficult to find and rarely offered by lenders.

• Hard to find a lender: Even though USDA backs them, not many lenders offer this type of loan
• Lengthy closing times: USDA construction loans require patience from 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.
• Paying guarantee fees: USDA charges both upfront and annual guarantee fees based on your loan amount. The annual fee is broken into 12 installments and included in your regular monthly mortgage payment
• Higher interest rates: The interest rate you’ll be charged will likely be higher than for a standard home purchase or refinance loans

However, you might only be stuck with that higher interest rate for a while.

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 many requirements and restrictions are 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% down payment requirements that other traditional lenders may stipulate with more associated risks.”

Who offers USDA construction loans?

Although there are big potential benefits to a USDA construction loan, it can be difficult to find lenders offering them.

“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.

USDA construction loan rates

As mentioned earlier, USDA construction loan rates 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 mortgage 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.

Alternative home construction and renovation loans

Here are a few other construction loan options to consider if you’re having trouble finding USDA loans or want to widen your search:

• VA one-time close construction loan: VA loans, backed by the Department of Veterans Affairs, are available to qualified veterans and active-duty military members. Like USDA loans, they can provide up to 100% financing
• FHA one-time close construction loan: Backed by the Federal Housing Administration, FHA loans are popular with first-time home buyers because they require as little as 3.5% down and have lenient credit guidelines
• Conventional one-time close construction loan: Conventional loans, backed by Fannie Mae and Freddie Mac, typically require a credit score of 620 or higher and at least 5% down
• FHA 203k loan: This FHA loan program can be used to finance the purchase price and cost of renovations on an existing fixer-upper home. Requires only 3.5% down and a 580 credit score
• USDA loan: A traditional USDA home loan can be obtained after getting a separate lot loan and/or construction loan

The right type of construction loan depends on your location, home building budget, credit score, and down payment, among other factors. You should ensure you’ve explored all your options and found the best loan before signing on.

USDA construction loans FAQ

Check your construction loan options

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.