When it comes to financing a home purchase, there are various mortgage options available to homebuyers, each with its own unique features, requirements and advantages.
When deciding if a USDA loan is right for you, it’s helpful to compare these loans to other loan types, such as FHA, VA and conventional loans, to help you determine which option best suits your needs and goals.
When it comes to mortgage loans you have a few options to choose from. Two popular types of home loans are USDA loans and conventional loans. But you may be wondering – is USDA considered a conventional loan?
The short answer is no. While both are mortgages that can help you buy or refinance a home USDA and conventional loans have some important differences.
In this article, I’ll explain what makes a USDA loan different than a conventional mortgage, discuss eligibility requirements, and compare the pros and cons of each type of home loan. My goal is to provide you with a clear understanding of conventional vs. USDA loans so you can determine which is the better fit for your needs.
What is a USDA Loan?
First let’s start with what exactly a USDA loan is. USDA stands for the United States Department of Agriculture. The USDA has a Single Family Housing Guaranteed Loan Program that helps eligible borrowers in rural areas get low-interest mortgages.
With a USDA loan:
- The mortgage is insured by the federal government.
- The USDA guarantees the mortgage, meaning if the borrower defaults, the USDA will repay the loan.
- Because they are government-backed, USDA loans offer competitive interest rates.
- Lenders can issue USDA loans with zero down payment.
The trade-off is these loans come with location and income restrictions that we’ll discuss more below.
What is a Conventional Loan?
A conventional loan is a mortgage that is not insured or guaranteed by the federal government. There are two main types of conventional loans:
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Conforming loans – These meet guidelines set by Fannie Mae and Freddie Mac and are eligible to be purchased by these two government-sponsored enterprises. Conforming loans adhere to maximum loan limits that vary by county.
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Non-conforming loans – These don’t meet the standards for conforming loans. There is more flexibility with non-conforming loan amounts, down payments, and borrower qualifications.
The most common type of conventional loan is a conforming 30-year fixed-rate mortgage. While conventional loans aren’t directly government-backed, they are considered less risky than other mortgages.
Main Differences Between USDA and Conventional Loans
Now that we’ve defined both loan types, let’s summarize the key differences:
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Location eligibility – USDA loans can only be used to purchase homes in designated rural areas. Conventional loans don’t have location restrictions.
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Occupancy – USDA loans must be used as a primary residence. Conventional loans can also be used for second homes or investment properties.
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Income limits – There are maximum income caps to qualify for a USDA loan that vary by region. Conventional loans don’t have income limits.
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Down payment – USDA loans require 0% down. Conventional loans typically need a minimum down payment of 5%.
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Mortgage insurance – USDA loans charge an upfront guarantee fee and annual fee. Conventional loans under 20% down require private mortgage insurance.
Hopefully this gives you a general idea that USDA and conventional loans have distinct eligibility criteria and features. Next we’ll take a deeper look at the specific requirements.
USDA Loan Requirements
To qualify for a USDA-backed mortgage, you must meet requirements related to:
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Location – The home must be in an eligible rural area as designated by the USDA. You can check your address on their property eligibility site.
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Income – Your household income must be below the limit for your county and family size. Income caps range from $60,000 to $143,050 depending on the area.
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Credit score – You’ll need a minimum credit score of 640 for streamlined approval. Scores between 600-639 require manual underwriting.
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Debt-to-income ratio – Your DTI should be below 41% to qualify. The USDA may make exceptions for higher DTIs with compensating factors.
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Occupancy – USDA loans can only be used to purchase or refinance your primary residence where you’ll live full-time.
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Down payment – No down payment is required. However, you will pay closing costs.
As you can see, USDA home loans help rural, low-to-moderate income borrowers by offering no money down and flexible credit requirements. But you do need to meet the specific eligibility criteria.
Conventional Loan Requirements
Next, let’s look at what you’ll need to qualify for a conventional mortgage:
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Credit score – Most lenders require a minimum score of 620 for conventional loans. The higher your score, the better your interest rate will be.
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Down payment – You’ll need at least 5% down for a conventional loan. With 3-5% down, you’ll pay private mortgage insurance.
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Debt-to-income ratio – Your DTI should generally be below 50%. Ratios above 36% may require additional approval.
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Loan limits – For conforming conventional loans there are maximum loan limits that vary by county, typically between $647,200 to $970,800.
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Property type – Conventional loans can be used to purchase primary residences, second homes or investment properties.
The bottom line is that conventional lending standards are a bit more flexible than USDA loans, but you typically need more funds upfront for your down payment.
Pros and Cons of USDA vs. Conventional Loans
We’ve covered the basics of how these two home loans work. Here’s a quick rundown of the main advantages and disadvantages of each mortgage type:
Pros of USDA Loans
- No down payment or minimum cash required
- Available for low to moderate income borrowers
- Competitive interest rates
- Lower credit score requirements
Cons of USDA Loans
- For rural locations only
- Limit on income level
- Upfront and annual guarantee fees
- Slower approval process
Pros of Conventional Loans
- Available nationwide
- No income limits
- Can be used for primary home, second home or investment
- Flexible terms and loan amounts
Cons of Conventional Loans
- Require 5-20% down payment
- Private mortgage insurance if under 20% down
- Higher credit score requirements
- Debt-to-income ratio limit
As you weigh the pros and cons, think about your specific situation. If you want to buy right away with minimal cash, need flexible credit, and are purchasing in an eligible rural spot, a USDA loan may be the way to go.
Conventional loans offer more flexibility if you don’t face income or geographic limitations. Just keep in mind you need funds saved for the down payment.
The Bottom Line: USDA is Not a Type of Conventional Loan
To wrap things up, USDA loans and conventional mortgages are two distinct types of home loans. While both can help you buy or refinance a home, USDA loans are government-backed loans designed for rural borrowers who meet income caps.
Conventional loans have fewer restrictions but come with mortgage insurance if you put less than 20% down. When you apply for a mortgage, ask your lender if you may qualify for both loan types to compare the options. That will help you determine if a USDA loan or conventional loan better suits your home buying needs and financial situation.
USDA Loans vs. FHA, VA and Conventional Loans
| USDA | FHA | VA | Conventional | |
|---|---|---|---|---|
| Eligibility Requirements | Designated rural area | Consistent employment for two years | Military Veteran, active service member, member of National Guard or Reserves or surviving spouses | Determined by borrower’s financial situation |
| Minimum Down Payment | None | Generally 3.5% of loan amount | None | Typically 5-20% of loan amount |
| Minimum Credit Score | None | 580 | None | 620 |
| Maximum Income Limit | 115% of area’s median household income | None | None | None, with the exception of HomeReady and Home Possible loans |
| Maximum Loan Limit | None | $498,257 – $1,149,825 | None for Veterans with full entitlement | $766,550 – $1,149,825 |
| Minimum Property Requirements and Occupancy | Must serve as primary residence, be a single-family home and adhere to USDA MPRs | Must serve as primary residence and adhere to FHA MPRs | Must serve as primary residence, adhere to VA MPRs and buyer must move in within 60 days of closing | Can be used for any type of residence, including investment properties and second homes |
| Mortgage Insurance | No PMI required | Required | No PMI required | Required if down payment is less than 20% |
| Closing Costs and Fees | Typically 2-6% of total loan amount and up to 6% seller concessions | Typically 2-5% of total loan amount and up to 6% seller concessions | Typically 3-6% of total loan amount and up to 4% seller concessions | Typically 3-6% of total loan amount and up to 9% seller concessions with at least 25% down payment |
Disadvantages of VA Loans vs. USDA Loans
Along with their advantages, VA loans also have some disadvantages compared to USDA loans:
- To qualify for a VA loan, borrowers must be eligible Veterans or active-duty service members.
- While VA loan limits no longer apply to those with their full VA loan entitlement, there are still limits in place for those with reduced entitlement. In these cases, VA loans are typically capped at $766,550, but this limit may increase up to $1,149,825, depending on the location of the property.
- Though VA loans have a similar range of total closing costs when compared to USDA loans, this loan type has a maximum seller concessions limit of 4%.
The choice between USDA loans and VA loans will depend on your personal situation and eligibility criteria. Veterans and active-duty service members can benefit greatly from the advantages offered by VA loans, while USDA loans provide an excellent option for those seeking affordable homeownership in eligible rural locations.
What’s The Difference Between a Conventional Loan and a USDA Loan?
FAQ
What is the difference between a conventional loan and a USDA loan?
What type of mortgage is USDA?
What loans are considered conventional?
Is a USDA loan the same as a FHA loan?
Why do USDA home loans have lower rates than conventional mortgages?
In addition to having no down payment requirements, USDA home loans often also have lower rates than conventional mortgages because the government is taking on the risks associated with lending. This is true even when the USDA issues the loans.
What is the difference between a USDA loan and a conventional loan?
Here’s an overview of some key differences between these types of loans: Do USDA loans require private mortgage insurance (PMI)? USDA loans do not require PMI, as PMI is only for borrowers of conventional loans who put down less than 20 percent.
Is a USDA loan a good idea?
Since the USDA is taking on a lot of the risk, your lender can offer you a lower interest rate. Ultimately, government-backed loans make it affordable for lower-income households to buy a home. Unlike USDA loans, conventional mortgages aren’t insured by the U.S. government. Conventional loans fall into two categories: conforming and non-conforming.
Can you qualify for a USDA loan?
If you can qualify for a USDA loan you can take advantage of one of the loan’s biggest advantages: potentially lower interest rates than conventional mortgage products offer. USDA loans are available to borrowers with credit scores low enough that they might not be able to qualify for a conventional mortgage.