USDA vs. FHA Loans: What’s the Difference?
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US Department of Agriculture (USDA) and Federal Housing Administration (FHA) mortgage loans are generally easier to qualify than a traditional mortgage. This makes them great options for first time buyers and low to middle income borrowers.
Although both loans are endorsed by government agencies, there are some important differences between the two that you need to consider before applying for a loan. For example, USDA loans require that you live in a rural location and meet your area’s income limit.
Here’s a closer look at each loan program so you can decide which one will best suit your needs:
USDA vs. FHA eligibility
The USDA and FHA both offer home loans for single-family homes.
For an FHA loan, apply for a simple 203 (b) mortgage loan to buy your primary residence.
However, there are two USDA home loan programs to choose from, and the eligibility standards are slightly different:
- USDA Guaranteed Loan: For low to middle income households that a private lender spends but the USDA supports. You have no credit limit or ownership restrictions on this loan.
- USDA Direct Loan: For low and very low income borrowers who need additional underwriting. The USDA is funding the loan and has stricter income and property qualifications. Also, most counties have a credit limit of $ 285,000.
Here are the basic requirements that you must meet for any loan:
|USDA loan||FHA loans|
|Income limits||Up to 115% of median household income||None|
|Debt-Income Ratio (DTI)||
||$ 356,362 for single family homes in most areas|
|Location requirements||USDA eligible rural areas only||None|
|Qualifying property types||Single family primary residences only||Main residences between 1 and 4 units|
|Mortgage repayment terms||30 years||Fixed for 30 years, fixed and variable for 15 years|
|Prepayment||1% guarantee fee||1.75% mortgage insurance premium upfront|
|annual fee||0.35% annual fee||Up to 0.85% annual mortgage insurance premium|
See also: Conventional Loan Requirements
USDA home loans have stricter income limits than FHA loans and also require you to live in an eligible rural area. Your home address and annual household income determine the borrower’s eligibility for USDA loans.
The requirements for FHA borrowers, on the other hand, are more lenient as you may have a lower credit score. Multi-family houses are also eligible. However, with an FHA loan, you will need to make a down payment.
USDA vs. FHA vs. conventional
Many home buyers use a USDA, FHA, or conventional mortgage to buy their home. Here’s a closer look at how these three loan types differ.
These loans are only available to low- and middle-income rural homebuyers. Income limits vary depending on the region, but are relatively strict. USDA loans do not require a down payment, but they do require a credit rating of at least 640 and must pay a 1% upfront guarantee fee and an annual fee of 0.35% of your loan amount.
The government mortgage programs may have the easiest time to qualify for an FHA loan. They only require a 3.5% deposit if your credit score is at least 580.
With that in mind, unless you can put at least 10% off, you are most likely paying mortgage insurance for the life of the loan. In this way, you can waive your remaining payments after 11 years.
Traditional mortgages have the toughest credit requirements, but they are also competitively priced and can be cheaper in the long run. For example, you can avoid private mortgage insurance with a down payment of at least 20%.
Credible doesn’t offer FHA or USDA loans, but we can help you find a cheap interest rate on a conventional loan. Just fill in some basic financial information and you will see several pre-qualified tariffs in minutes. After that, you can explore your loan options and find the one that best fits your budget.
USDA pros and cons
USDA loans offer several advantages to borrowers, but you also need to consider some of the disadvantages.
Here are some of the best reasons to consider a USDA loan:
- No minimum deposit: Conventional loans and FHA loans both require some type of down payment, but USDA loans do not have such a requirement.
- May not require cash reserves: Lenders are not allowed to ask for cash reserves to secure funding. However, including your qualifying credits can make qualifying easier.
- No fixed maximum purchase price: USDA loans have no credit limit. Instead, your maximum loan amount depends on your repayment ability.
- Lower mortgage insurance fees: Your USDA upfront guarantee fee is 1% of the loan amount and the annual fee is 0.35%. Both rates are lower than FHA mortgage insurance premiums.
- The seller can bear the closing costs: The seller can contribute up to 6% of the sales price. You can also get unlimited gift credit to reduce your loan amount.
These are the main disadvantages of this loan program:
- Good Credit Required: You need a credit rating of at least 640 to be eligible for this loan, similar to traditional lenders. FHA lenders can only require a score of 580 or less.
- Geographic restrictions: You must live in a rural area to qualify for USDA funding. Fortunately, the definition is flexible and many suburban and bedroom communities may be eligible if the population is below a certain amount.
- Maximum income limits: For a USDA-guaranteed loan, your household income cannot exceed 115% of the county median household income (MHI). Households with income 80% below the MHI must apply for a USDA direct loan. Direct loans may have stricter ownership and application requirements but, like guaranteed loans, do not require a down payment.
- Lifetime guarantee fee: All USDA loans require an upfront payment and an annual guarantee fee for the life of the loan. Unlike FHA and traditional loans, paying a qualified down payment doesn’t affect whether or not you pay for mortgage insurance.
- Single family houses only: Single-family houses are the only type of property eligible for funding. This includes townhouses and condos as long as you use the unit for your primary residence. Investment property is not eligible.
FHA pros and cons
FHA loans are a great option, especially if you have a low credit score or high debt. But they also have their own drawbacks.
Some of the best reasons to apply for an FHA home loan are:
- Compliant credit requirements: You can generally qualify for maximum FHA funding with a credit score of 580 versus a 640 score for a USDA loan. You may also be eligible with a credit score between 500 and 579 if you can pay a 10% deposit.
- Higher debt-to-income ratios: Your back-end DTI – which is your total monthly debt obligations – can be up to 45% for FHA loans but only 41% for USDA loans.
- Potentially lower interest rates: FHA rates can be lower than USDA loan rates because you have the option to choose shorter repayment terms, including a fixed rate of 15 years. The USDA only offers 30 year fixed loans, which of course have higher interest rates.
- Multi-family houses can qualify: Properties of up to four units can qualify for FHA loan financing if one unit is your primary residence. For example, buying a maisonette with an FHA loan is allowed as long as you live in one half of the property. However, like USDA loans, second homes and investment properties are ineligible.
- Higher deposit requirements: Depending on your credit rating, you will need to pay a 3.5% or 10% deposit. USDA loans do not require a down payment.
- Higher premiums for mortgage insurance: Your upfront and annual mortgage insurance premiums are higher than the USDA guarantee fee and the annual fee.
- Difficult to cancel mortgage insurance: You pay an annual mortgage insurance premium for the life of the loan, unless your down payment is at least 10% – in which case you only pay mortgage insurance for the first 11 years.
- Mortgage Limits: The maximum loan amount in 2021 for most counties is $ 356,362. You can qualify for a higher limit if you live in a high cost area.
Continue reading: FHA vs. Conventional Loans: Which One Is Right For You?