When it comes to affordable housing loans, two popular options are FHA loans and USDA loans Both are government-backed mortgage programs aimed at helping lower income borrowers achieve homeownership But there are some key differences between FHA and USDA loans that buyers should understand before choosing one.
In this comprehensive guide, we’ll compare FHA and USDA loans side-by-side. We’ll look at eligibility requirements loan limits, down payments, mortgage insurance, interest rates and more. By the end, you’ll have all the information you need to determine if an FHA or USDA loan is the better fit for your budget and home buying goals.
Overview of FHA and USDA Loans
First, let’s briefly introduce the two loan programs.
What is an FHA Loan?
FHA loans are insured by the Federal Housing Administration (FHA), which is part of the Department of Housing and Urban Development (HUD). Because the FHA guarantees these loans, lenders can offer more flexible underwriting standards. FHA loans only require a minimum credit score of 580 and a 3.5% down payment.
Nearly any borrower who meets basic FHA eligibility criteria can qualify, regardless of location or income level. FHA loans can be used to purchase single-family homes, condos, multifamily properties, and manufactured homes.
What is a USDA Loan?
USDA loans are backed by the U.S. Department of Agriculture. The program helps low-to-moderate income borrowers in rural and suburban areas achieve homeownership. USDA loans offer 100% financing, meaning no down payment is required.
However, borrowers must meet income limits set by the USDA, not exceed 115% of the median income for their area. The home must be located in a USDA-designated rural or suburban zone. Only single-family homes and townhouses qualify.
Comparing Eligibility Requirements
When deciding between an FHA loan or USDA loan, the first thing to look at is whether you meet the eligibility criteria for each program.
Credit Score Requirements
FHA has more lenient credit standards than USDA loans. The minimum FICO score for an FHA loan is just 580 if you make a 3.5% down payment. USDA loans require a credit score of 640.
Those with scores between 500-579 can still potentially qualify for an FHA loan with a 10% down payment. USDA loans aren’t available to buyers with credit scores below 640.
Down Payment Requirements
A major benefit of USDA loans is that they require zero down payment. Borrowers can finance 100% of the home’s purchase price plus closing costs.
FHA borrowers need at least 3.5% down if their credit score is 580 or higher. A 10% down payment is required for FHA applicants with scores between 500 and 579.
Debt-to-Income Ratio
Your debt-to-income ratio (DTI) compares your total monthly debt payments to your gross monthly income. Most lenders cap DTIs at 50% for conventional mortgages.
FHA allows ratios up to 55%, while USDA caps DTIs at 41%. So FHA provides more flexibility for buyers with higher levels of existing debts.
Home Location
Here’s where FHA and USDA loans differ significantly. FHA mortgages can be used to buy a home anywhere in the U.S. There are no location restrictions.
USDA loans are only available in designated rural and suburban locales. Properties must fall within USDA income and property eligibility guidelines. FHA loans are the way to go if you need to buy in a metro area.
Loan Limits
The maximum FHA loan amount depends on county-level home values but can go up to $970,800 in the most expensive housing markets for a single-family home.
USDA doesn’t publish maximum loan limits. However, borrowers must still prove they can repay the loan, and the home can’t have luxury features or be overly large for the area.
Income Limits
Here’s another major difference in FHA vs USDA eligibility. FHA mortgages come with no income limits at all. Regardless of what you earn, you can qualify for an FHA loan if you meet all the other requirements.
USDA home loans do have maximum income thresholds based on family size and location. In most areas, incomes cannot exceed 115% of the median income for that county or metro area.
Loan Features: FHA vs USDA
Now let’s compare some other important loan features side-by-side.
Types of Properties
FHA loans can be used to buy just about any residential property. This includes:
- Single-family homes
- Condos
- Duplexes
- Triplexes
- Fourplexes
- Manufactured homes
USDA loans are far more limited. Borrowers can only use them to purchase:
- Single-family homes
- Townhomes
- Manufactured homes
So FHA provides more flexibility if you’re looking to buy a multifamily home.
Mortgage Insurance
Both programs require mortgage insurance. FHA mortgage insurance is called an MIP. USDA mortgage insurance is a guarantee fee.
FHA MIP tends to be more expensive. There’s a 1.75% upfront premium and 0.45% to 1.05% annual premium. USDA charges a 1% upfront fee and 0.35% annual fee.
With FHA, you can cancel MIP once you reach 22% equity in the home. USDA mortgage insurance lasts for the full loan term.
Interest Rates
Government-backed loans like FHA and USDA often come with lower interest rates than conventional mortgages. USDA rates are extremely competitive thanks to the 100% financing and low mortgage insurance costs.
FHA interest rates are also attractive for buyers with lower credit scores. Rates for both loans will vary by lender.
Closing Costs
Closing costs for FHA and USDA loans depend on your lender but are generally affordable. USDA even lets you finance closing costs by rolling them into the mortgage. FHA restricts loan amounts to the purchase price.
Both programs allow you to offset closing costs through seller concessions (up to 6% of the purchase price).
The Best Loan Option For You
As you can see, FHA and USDA loans share some common traits but differ in other ways. So which is the better choice?
Here are some quick tips:
- If your credit score is below 640, FHA is your only option
- If you need zero down payment, USDA is preferable
- If you’re buying a multifamily home, choose FHA
- If your income exceeds USDA limits, go with FHA
- If you’re buying outside metro areas, USDA may be better
As always, be sure to talk to a loan officer about your specific situation. They can help you compare rates and costs for FHA vs USDA loans from multiple lenders. This ensures you find the most affordable mortgage option with the best terms for your needs.
Con: Income limits apply
The Rural Development Loan was created to spur homeownership in rural areas, especially among low- and moderate-income home buyers who might not otherwise qualify.
As such, the USDA publishes income limits. Maximums are set at 115% of the median income for your county or area. But these limits aren’t overly restrictive. The following are examples of maximum household incomes in various locales around the country:
- Denver, Colorado: $112,850
- Portland, Oregon: $105,950
- Philadelphia, Pennsylvania: $111,100
- Albany County, Wyoming: $92,450
You can find the current USDA income requirements for your area here.
Not everyone will fall within the USDA income limits. That’s where FHA comes in. FHA loans come with absolutely no income limits for their standard program.
Con: You must buy in a rural location
USDA eligibility depends on the location of the home. You must purchase a property in a rural area as the USDA defines it. But the definition of “rural” is quite liberal, and it’s based on U.S. census information from more than 15 years ago. So many suburban areas are still eligible.
USDA publishes online maps that buyers can use to check the eligibility of a certain address or geographical area. Buyers will find that some entire states are USDA-eligible. Even highly populated states contain surprisingly vast qualifying areas. An estimated 97% of the American landscape is geographically eligible for a USDA loan.
Still, some buyers might find that eligible areas are too far outside employment centers and, for that reason, choose an FHA loan, which comes with no geographical restrictions.
Are USDA or FHA Loans Better?
FAQ
Is USDA or FHA better?
What is one advantage a USDA loan has over the FHA loan ______?
Are USDA loan payments cheaper?
What credit score do you need for a FHA and USDA loan?
How do I qualify for an FHA vs USDA loan?
Being eligible for an FHA vs. USDA loan means meeting specific requirements. To qualify for an FHA loan, prepare to: Make a down payment of at least 3.5% with a credit score of 580 or higher, or a down payment of 10% with a credit score between 500 and 579. Pay an upfront mortgage insurance premium at closing equivalent to 1.75% of the loan.
Are USDA vs FHA loans better?
When comparing mortgage options, such as USDA vs FHA loans, the better choice largely hinges on one’s financial situation. For instance, individuals with lower credit scores may discover that FHA loans suit their needs best.
Why are USDA and FHA loans so popular?
Home buyers with low or moderate incomes may gravitate toward mortgages with more lenient borrowing requirements, especially when it comes to down payments and mortgage insurance. This is why USDA and FHA loans can be so appealing to borrowers. How do the two types of mortgage loans differ, though?
What is the difference between FHA and USDA mortgages?
The FHA program offers 30-year and 15-year fixed-rate mortgages, along with adjustable-rate mortgages (ARMs). The USDA offers only a 30-year fixed-rate loan. In addition, both programs require you to buy a primary residence, meaning you can’t use them for a vacation home or investment property.