Loan Options For Farm Buyers
I get a lot of questions about which loan programs are best for farm buyers. There is so much information out there regarding loans and it’s impossible to cover every situation since every buyer’s financial situation is unique. Before we dive in, I want to touch on a few items. Firstly, most loan programs don’t have acreage limits in the strictest sense. Usually, if there is any kind of acreage limit, it has more to do with how much of the property’s appraised value comes from the land. For instance, if you are purchasing a farmette, a loan program might require that no more than 30% of the property’s value can come from land. This means the home and the outbuildings would need to account for at least 70% of the property’s appraised value (buying land is a different process). Secondly, it is really important to remember that even with zero down loans, you will still have closing costs due at settlement which are usually 3%-6% of the loan amount so you need to account for this as an out of pocket expense. Talk to your real estate agent about negotiating to have the seller cover closing costs. It is also important to note that government loan programs offer direct and guaranteed loans. With a direct loan the government program serves as the lender and you apply directly through them. However, many buyers apply for a guaranteed loan through a participating lender who specializes in these loan programs. For example, a local lender who specializes in USDA loans can take applications and underwrite the loan before the USDA gives final approval.
There are a number of loan options available to farm buyers and it is not always immediately clear to a buyer which option will make the most sense. Nevertheless, it’s really important to get pre-approved before you start looking at farms. A pre-approval letter not only gives you a solid budget to stick to, but it is an essential piece of any offer. Some sellers even require buyers to obtain pre-approval before they will allow them to tour a property. Since the average farm buyer takes 3-6 months to purchase a farm, it would be a shame to find the perfect place only to lose the bid to another buyer when you can’t get a pre-approval letter in time. Many buyers are able to get their pre-approval letter within a day or two of speaking with a lender. When you sit down with a lender (or, in many cases, speak to them over the phone), they will ask for financial information like pay stubs, tax returns, and bank statements. They will also check your credit score and look into your debt-to-income ratio (DTI). Debt includes monthly expenses like student loans, credit card bills, and car payments. The lender will factor in the future monthly mortgage payment and determine a percentage. The acceptable DTI percentage will vary based on the type of loan. In this article, we’ll cover DTI and other features of the loan programs most commonly used by farm buyers.
Conventional Loans. Many buyers are surprised to realize that they qualify for a conventional loan when purchasing a farm. Conventional loans are the most common type of home loan and many of my farm buyers finance their purchase this way. However, it is important to remember that not all lenders are created equal. Be sure to choose a lender who is familiar with the farm buying process so important steps like the appraisal go more smoothly. If you work in the farming or equestrian industry, a lender who understands what you do will certainly come in handy.
1. You do not need to put 20% down for a conventional loan, but be aware that you will need to pay Private Mortgage Insurance (PMI) monthly until you reach 20% equity.
2. Lenders must stop charging PMI when the borrower reaches 22% equity, but you can contact your lender to stop the PMI charges when you have 20% equity in the home.
3. Interest rates vary lender to lender and will depend on a number of factors including timing, credit score, loan amount, and the amount you put down.
4. In some instances, lenders may be able to lend up to a 49% DTI on conventional loans.
Farm Credit. Many farm buyers have heard of Farm Credit and wonder how it differs from a USDA loan. MidAtlantic Farm Credit is a large agricultural lender owned by a co-op and serves Delaware, Maryland, Pennsylvania, Virginia, and West Virginia. There are similar lenders in other parts of the country and you don’t have to be a professional farmer to finance a real estate purchase with Farm Credit. There are loan options for farms, rural homes, land, and construction. Here are some of the most interesting features of Farm Credit:
1. Farm Credit is owned by a co-op which means that up to 60% of their profits are returned to borrowers annually.
2. You may also finance business expenses, equipment, and construction. Need to build barns? Install fencing? Purchase a tractor? Farm Credit may be able to help you finance it.
3. Farm Credit also works with government loan products like FHA, VA, and USDA.
FHA Loans. This loan type is one of the most common and it is typically what people think of when considering loan options with minimal down payments. If you plan on buying a farm as your primary residence, then an FHA loan could be a good option. Here are the basic requirements:
To qualify for a 3.5% down payment, you will need a credit score of at least 580.
If your credit score is between 500 and 579, you will need to put down 10%.
Similar to PMI for conventional loans, FHA loans will require borrowers to pay MIP (Mortgage Insurance Premium) both upfront at closing and on a monthly basis. The current rate is 1.75% of the loan amount upfront and generally around .85% annually afterwards. The annual amount varies depending on factors like the loan amount and the down payment.
The DTI is generally 43%, but there are circumstances in which a borrower could secure a loan with up to a 56% DTI.
USDA Loans. USDA loans are frequently of interest to farm buyers because USDA loans are the only zero down loan apart from VA loans. There are no acreage limits on USDA loans and they are not just for farms. This loan type helps buyers purchase residential properties including new builds, and manufactured homes in rural areas. Some suburbs may also qualify. The USDA has a map on their website that allows buyers to search addresses to see if a property might be eligible, but this doesn’t guarantee the property or the buyer will ultimately be eligible for a USDA loan. Here are a few important features of USDA Loans that you need to be aware of:
1. There is an income limit based on number of people in household. The income limit is for the total household income. For households with 1-4 members, the limit is $86,850 most places, but in high cost areas the limit is higher at $212,550. The limit for households with 5-8 members is $114,850 for majority of the country and $280,550 for high cost areas.
2. Like an FHA loan, a Mortgage Insurance Premium (MIP) is charged monthly and will amount to .35% of the loan annually which is 40% less than MIP on FHA loans.
3. The DTI is technically 46%, but it is rare to be approved with this DTI. The lender will want to see a lot of reserves in the bank to approve it, but if you have enough for a 20% down payment in the bank then you won’t qualify for the loan at all, so it is fine line. Generally, the lender will want to see the equivalent of 1-2 months of payments reserved in bank.
4. USDA loans require a credit score of 580 which is the same as an FHA loan. However, most lenders will want to see a score of 640.
5. USDA loans go through the Guaranteed Underwriting System (GUS). The lender will have to run the numbers through GUS or the pre-approval can’t be trusted since the system is a bit finicky.
6. It can take a while for final loan approval because loan will essentially be underwritten twice and there is no way to rush it. The loan will first be underwritten by the lender and then it will go to the USDA for final approval (You can also apply directly through the USDA). Loans are processed on a first come, first serve basis.
VA Loans. If you’ve served in the military, you may be able to finance the purchase of your farm with a VA loan. This loan type has several distinct advantages including zero down payment and lower interest rates. Borrowers can have up to a 41% DTI. There are a few changes that have recently taken effect including increases in funding fees. A funding fee is a one-time payment at closing. Since VA loans don’t require a down payment or mortgage insurance, borrowers need to pay this cost at closing unless they meet certain requirements. Here are the two most recent changes:
1. There are no loan limits anymore.
2. The funding fee for zero down loans is now 2.3% of the loan amount for first-time buyers and 3.6% for subsequent loans. The fees are due to drop again in 2022.
Please remember that I am not a lender and that these are not the only loan programs available to farm buyers. Each state and each lender might provide additional options and even within the programs I’ve outlined above, there is variation. For example, Maryland offers a number of first-time homebuyer programs and I’ve spoken to lenders who offer programs tailored to borrowers in certain career paths. The USDA’s Farm Service Agency (FSA) lends to farmers and ranchers and may occasionally run programs to support new farmers. Since there are so many options out there for borrowers to explore, I encourage my buyers to find a local lender if at all possible. Local lenders are more familiar with local and state loan programs and can help buyers tailor a loan to their needs. They also tend to be easier to get in touch with which is vital to ensuring a successful transaction.