USDA loans are a great option for home purchases in a designated USDA Rural Development area. Offering 100% financing without a requirement for a down payment, competitive loan rates, and flexible credit requirements, these loans make homeownership accessible to a wide range of borrowers who choose to live in a rural area. Additionally, USDA loans offer affordable mortgage insurance through a guarantee fee instead of PMI.
Guarantee Fee Instead of PMI
Conventional loans require PMI (private mortgage insurance) if the borrower puts down less than 20% of the home’s purchase price. PMI protects the lender in case the borrower defaults on the loan and is calculated based on several factors, including the loan amount, loan-to-value (LTV) ratio, and borrower credit score.
USDA mortgages by the Department of Agriculture don’t require homeowners to have Private Mortgage Insurance (PMI) like a conventional loan, as the U.S. Government backs them. Instead, they require borrowers to pay a guarantee fee.
Calculated as a percentage of the total loan amount, the USDA guarantee fee consists of an upfront guarantee fee payable at closing and annual fees integrated into the borrower’s mortgage payment. Typically lower than PMI premiums, the guarantee fee makes USDA loans more affordable for borrowers, supporting the program’s goal of fostering homeownership and economic development in rural areas.
USDA Mortgage Insurance Costs
Although USDA loans do not require PMI, there are USDA mortgage insurance costs. Borrowers must have homeowners insurance and flood insurance for areas prone to flooding.
The purpose of homeowners insurance is to protect the home from fire damage, floods, and other weather-related events. The lender wants to ensure that the collateral is fully insured against unexpected events for the duration of the home loan.
What is Homeowners Insurance for USDA Loans?
When you apply for a USDA loan to buy a home, homeowners insurance requirements to close the loan indicate that the homeowner’s insurance policy must include the following items:
Home insurance coverage to match the housing loan amount
The insurance must cover the amount the lender is lending the borrower through the mortgage. The amount of homeowners insurance must also cover the cost of rebuilding the home in the event of a total loss, such as a fire. This is known as the replacement cost, which differs from the home’s market value. The replacement cost focuses solely on the expenses of reconstructing the house, including materials and labor.
The replacement cost is calculated based on factors such as the home’s size, the age of the property, the construction type, the location, and the cost of construction materials and labor in the area.
If the insurance coverage is lower than the loan amount, the insurance company needs to provide a Replacement Cost Estimator (RCE). This document breaks down how the homeowner’s insurance company arrived at their dwelling coverage amount. This document, along with the homeowner’s insurance, should be enough to clear the condition, but it is also at the underwriter’s discretion.
Named insured and mortgagee clause to match loan documents
The homeowner’s insurance policy must have the insured person(s) match the person(s) on the loan. The Mortgagee section should also have the lender’s Mortgagee Clause, including the loan number. All of these items should match the loan documents exactly.
Acceptable deductible
The deductible for USDA homeowners insurance policies must be either 1% of the dwelling coverage or $1000 — whichever is greater. For example, if a policy’s dwelling coverage amount is $160,000, the deductible can exceed $1000, up to a maximum of $1600, but no greater. Higher deductibles lower the insurance cost but also mean that the borrower gets to pay more in case of a disaster.
What Does Homeowners Insurance Cover for a USDA Loan?
Dwelling coverage
Homeowners insurance covers dwelling coverage. This is the core part of a homeowners insurance policy, which promises to pay the cost to repair or rebuild the home if it’s damaged or destroyed by an insured event like fire, storm, hail, or vandalism. It includes the main structure of the house and attached structures, such as a garage. The most common dangers the insurance covers are fire, lightning, theft, vandalism, storms, damage from vehicles and aircraft, riots, and civil commotion.
Personal property coverage
Extra coverage can be included, such as personal property coverage for the home’s contents, including furniture, appliances, clothing, and other personal belongings, against theft or damage from covered perils. High-value items may require additional coverage through endorsements or riders.
Liability protection
Liability protection provides coverage if someone is injured or their property is damaged and you are found legally responsible. It can cover legal fees, medical bills, and damages awarded in a lawsuit up to the policy’s limit.
Loss of use or ALE
Loss of use or additional living expenses (ALE) will cover you if the home is uninhabitable due to a covered loss. This coverage helps pay for temporary living expenses, such as hotel bills, meals, and other costs incurred while the home is being repaired or rebuilt.
Medical payments
Medical payments cover medical expenses if someone is injured on your property, regardless of fault. They are typically meant for minor incidents and are limited to a specific amount per person.
How Does The Homeowners Insurance Get Paid?
USDA home loan borrowers often have their homeowners insurance included in their monthly mortgage payments through an escrow account.
How does an escrow account work?
The lender collects the insurance premium along with the mortgage payment and pays the insurance premium on your behalf. This arrangement helps keep the insurance current and reduces the risk of lapses in coverage. Your mortgage insurance premium is rolled into your monthly mortgage payments. It’s a streamlined process that keeps payments up-to-date.
Flood insurance Premiums
When FEMA considers a home to be in a Flood Zone, the lender may require flood insurance. The home loan process in high-risk flood zones, as designated by FEMA’s flood maps, is more likely to require flood insurance, especially if the homeowner has a mortgage from a federally regulated or insured lender.
The appraisal report and a flood certificate indicate this early on in the process. For USDA home loans, flood insurance has the same guidelines as regular homeowners insurance for dwelling coverage, including restrictions on deductible amounts.
Flood insurance is usually purchased as a separate policy from the National Flood Insurance Program (NFIP), managed by the Federal Emergency Management Agency (FEMA), or from private insurance companies offering flood insurance policies. The only difference is the underwriter requires the invoice to show as paid in full.
Flood insurance covers damage to the building structure and contents due to flooding. This can include repair or replacement costs for the structure of the home, electrical and plumbing systems, permanently installed carpeting and cabinets, and personal belongings like furniture and clothing.
How Do I Prove I Have Homeowners Insurance for My USDA Loan?
An insurance binder, Evidence of Insurance, Memorandum of Insurance, or Certificate of Insurance are all acceptable documents up to closing.
However, lenders require a Homeowner’s Declaration Page and Invoice at closing. Evidence of Insurance and other documents have premiums and coverage that can be changed.
Due to USDA’s strict guidelines, if the premium increases beyond what has been previously accepted, the first-time home buyer may be ineligible for the loan due to debt-to-income ratios.
For the USDA loan program, the first-year annual fee is part of the closing costs. It is paid at closing by the first-time home buyer’s lender out of the escrow account. This ensures that at least the first year is covered by the loan closing.
PMI On USDA Loan
Interested in finding out more about USDA loans and PMI? Contact us today and talk to a mortgage Loan Officer. Our Mortgage Society loan specialists have received USDA lender training. We will answer all of your questions and guide you every step of the way until you are a proud homeowner!
