USDA Loans Vs. FHA Loans: A Comparison

USDA loans and FHA loans offer many potential borrowers the opportunity to buy a home with more flexible requirements. These two government programs have helped millions of Americans find homes with terms that better fit their financial situation, but each program is somewhat different.

So, what is the difference between USDA and FHA loans? There isn’t a singular difference between the two of them. Instead, each program has slightly different qualifications and processes. If you’re considering both types of loans, find out which may be right for you.

USDA Loans And FHA Loans: Basic Principles

USDA loans and FHA loans are loan programs backed by the federal government, which insures the borrower’s mortgage against default. This protects the lender and adds a sense of security for them. Remember that the government is not funding these loans, they are only insuring them. You would still acquire either loan from a lender. By creating protections for the lender, the government creates a system where the requirements for these mortgages are more lenient so qualifying can be easier.

However, each of these programs is different. FHA loans are designed to help any income, but primarily low-income, prospective buyers finance a home. Meanwhile, USDA loans are only available to borrowers who live in a specified rural or suburban region and fall below a certain income.

What Are The Differences Between A USDA Loan And An FHA Loan?

USDA loans and FHA loans work by having the government protect a lender against loss if a borrower defaults on their loan. While the government backs each of these loans, USDA loans and FHA loans are managed by different government departments. USDA loans are backed by the Department of Agriculture, while FHA loans are insured by the Federal Housing Administration under the Department of Housing and Urban Development (HUD).

Because they’re both sponsored by different departments, each program has its own loan and approval requirements. For example, USDA loans don’t require a down payment, but FHA loans require at least a 3.5% down payment with a credit score of at least 580 or a 10% down payment with a credit score between 500 – 579.

USDA Loan Vs. FHA Loan Eligibility Requirements

USDA and FHA loans have different eligibility requirements that impact your mortgage both during the mortgage process and throughout the loan term.

There are several factors that differentiate USDA and FHA loans. They have different credit and down payment requirements, maximum DTIs, mortgage insurance costs, lending limits and closing costs. As we break down these qualifications, think about how these requirements may relate to your financial situation.

Income and Credit

While the minimum credit score to get a conventional loan is 620, borrowers who want a USDA loan need a minimum credit score of 640. However, you might be able to qualify with a lower score, depending on your lender. Borrowers who hope to get an FHA loan will need at least a 580 credit score with a 3.5% down payment or a median credit score of 500 or higher with a 10% down payment.

In addition to credit score, each of these programs has a DTI maximum. Your DTI is a percentage that shows lenders how much money you spend paying your debts vs how much money you earn. When you apply for a mortgage, lenders want lower DTI ratios since it means you’re spending less money paying off your debts and are more likely to be able to afford mortgage payments. In most cases, you want your DTI to be at or below 41%, but the maximum DTI for a USDA loan is 43%. Meanwhile, FHA loans have a maximum DTI of 57%, though it is decided on a case-by-case basis.

It’s important to know that credit and DTI requirements may differ depending on such factors as your lender, location and credit score.

While USDA loans have a lower maximum DTI than FHA loans, they also have income limits. To qualify for a USDA loan, your income can’t be more than 115% of the median income in your area. This loan maximum ensures that loans go to low- and moderate-income borrowers. FHA loans, meanwhile, don’t have any income limits. This means that anyone who wanted an FHA loan, regardless of income, could apply if they met the other qualifications.

Down Payment

A down payment on a house is the cash the buyer pays upfront, usually a percentage of the home’s final price. While USDA loans do not require a down payment, FHA lenders have two down payment options. If you have a credit score of 580 or higher, your down payment can be as low as 3.5%; if have a median credit score of at least 500, you will need a 10% down payment. Keep in mind that many lenders will require a minimum credit score of 580 for an FHA loan.

Larger down payments reduce the amount you spend per month on your mortgage and, for those with FHA loans, can influence how long you will pay a mortgage insurance premium (MIP).

Guarantee Fees vs Mortgage Insurance Premium Costs

While conventional loans have private mortgage insurance (PMI) for borrowers who put down less than 20%, USDA and FHA loans utilize guarantee fees and MIPs, respectively. These fees help pay for the insurance that the government gives your lender.

Borrowers who get a USDA loan pay a guarantee fee. This fee comes in two parts. First, an upfront fee where the borrower pays 1% of the loan, then an annual fee that comes out to .35% of your loan balance. Both fees have the option of being added to your loan amount as part of your monthly payment for the life of the loan.

FHA loans, on the other hand, require that the borrow pays an MIP. This mortgage insurance also has two parts: an upfront payment and a yearly premium. Your upfront payment will be equal to roughly 1.75% of your loan and can be added on to the loan balance or paid in full at closing. Your yearly premium will vary based on your down payment and your loan term. If you have a down payment of at least 10%, you can decrease the amount of time you pay mortgage insurance to 11 years. Otherwise, the MIP stays on for the life of the loan.

Lending Amounts

USDA loans do not have a loan limit, instead they have an income maximum when qualifying. FHA loans, meanwhile, do have a maximum loan limit. Essentially, you can’t buy a house that exceeds the amount specified by the Federal Housing Finance Agency (FHFA). For the 2022 calendar year, the loan limit is $420,680 in most areas of the U.S. and up to $970,800 in high-cost areas.

Closing Costs

Closing costs are the fees that buyers and sellers pay before finishing a real estate transaction. These fees range from roughly 3% – 6% of the home’s purchase price and can include appraisal fees, title insurance and origination fees. There can also be fees relating to the processing of your loan, property fees associated with your house (like a homeowners association or property taxes) and insurance fees.

In addition to paying the rest of these closing costs, borrowers with USDA and FHA loans have to pay their upfront USDA guarantee fee (roughly 1% of the loan) or their upfront FHA MIP fee (roughly 1.75% of the loan) at closing.

Pros And Cons Of USDA Loans

USDA loans, like every financial option, have a series of pros and cons associated with them. For some borrowers, they can be the perfect option to finance their home.

Pros

Since USDA loans are backed by the federal government, they have some more lenient terms for borrowers. This means that USDA loans offer certain advantages to those who want to use them:

• USDA loans do not require a down payment.
• They offer lower interest rates since they’re backed by the federal government.
• Your closing costs can be included in your mortgage and there is no pre-payment penalty.
• Your guarantee fees can be included in your loan.
• USDA loans allow financing for 100% of the appraised value of your home, so if your home is appraised for more than you bought it for, you can put some of that extra money into your closing costs.

Cons

No matter the advantages of USDA loans, there are a few drawbacks. Here are some things to consider when thinking about a USDA loan:

• Most lenders require a minimum credit score of 640, which is higher than an FHA loan and a conventional loan.
• There are geographic restrictions; borrowers must live in a qualified rural or suburban area.
• Your household income must be under a threshold set by the USDA for the area you want to live in. This ensures that the people who need these loans can get them.
• You will have to pay an annual and an upfront guarantee fee. These fees help the government insure your loan.
• There are limits on the type of property you can own. You cannot use a USDA loan to purchase a duplex home, investment property or a vacation home.

Pros And Cons Of FHA Loans

Like USDA loans, FHA loans have a series of requirements that might be good for some borrowers, but not quite right for others based on their advantages and disadvantages.

Pros

FHA loans are known for their more flexible standards and allow many people to own a home, even those who may not have had the option before. FHA loans offer many of benefits to their borrowers:

• FHA loans allow borrowers to make a minimum down payment of 3.5% if they have a credit score of 580 or higher.
• They also have more lenient DTI requirements, often lower than a conventional loan.
• Because FHA loans are backed by the government, they may offer better interest rates.
• Borrowers can add a co-borrower’s income to help qualify for an FHA loan, even if that person won’t be residing in the home.

Cons

Even though FHA loans can be a good option, there are some considerations to keep in mind:

• FHA loans come with upfront and yearly mortgage insurance premiums to help secure the loan. However, your down payment can impact how long and how much you pay.
• Because FHA loans are less exclusive, they can have an unfavorable stigma attached to them which may make your offers seem less attractive to sellers.
• FHA loans come with loan maximums which are based on where you want to live.
• You can’t use an FHA loan to finance a second property or a vacation home.

USDA Loan Vs. FHA Loan: Which Is Right For You?

While both loan options can help certain borrowers, there is most likely one with criteria that better matches your financial situation.

If meet the credit and income requirements of a USDA loan and plan on living in a rural area it may be the right loan for you. However, if you have a lower credit score and are still paying off debt, an FHA loan may be a better fit.

The Bottom Line: Understand The Difference Between A USDA And FHA Loan Before Applying

USDA and FHA loans have a variety of different requirements that make them ideal for different types of borrowers. Before choosing one of these options, it’s important to be aware of their differences and their requirements. Both loan programs offer more lenient requirements and better interest rates, which can help lower-credit or lower-income borrowers own a home.

While our friends at Rocket Mortgage^® don’t offer USDA loans, they do offer FHA loans. If you’re interested in an FHA loan and you think it may be right for you, get approved today.