Understanding the advantages of a USDA loan vs. conventional will help you choose the right mortgage for your needs.
Many homes in the suburbs also qualify for USDA loans, which allow you to buy with no money down. And borrowers with low to moderate incomes qualify, so more borrowers are likely eligible for these 100% financing mortgages than they realize.
Although conventional loans are the most common types of mortgages, theyâre not always the right option, especially for first-time homebuyers who have little money to put down.
Before you buy, itâs wise to evaluate the difference between a USDA loan vs. conventional loan so you can decide which one is right for you.
When buying a home, one of the biggest decisions you’ll make is what type of mortgage loan to get. Two popular options for many homebuyers are USDA loans and conventional loans. But an important question comes up: Is a USDA loan actually a type of conventional loan?
The short answer is no. While both are mortgage loans, USDA and conventional loans have some key differences.
Overview of USDA and Conventional Loans
First, let’s look at what defines each type of home loan
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USDA loans – Issued by private lenders but insured by the US Department of Agriculture. Designed to help low-to-moderate income borrowers in rural areas purchase a home.
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Conventional loans – Not backed by a government agency. The two main types are conforming and non-conforming loans. Conforming loans meet the requirements to be purchased by Fannie Mae and Freddie Mac.
So while the USDA guarantees USDA loans, conventional loans don’t have any government backing. This key difference means USDA loans are in a loan category of their own.
Major Differences Between USDA and Conventional Loans
Beyond the government backing, USDA and conventional loans differ quite a bit in their requirements and features:
Location
The property you want to buy must be in a designated rural area to qualify for a USDA loan, Conventional loans can be used anywhere,
Down payment
USDA loans require no down payment. With a conventional loan, you typically need at least 3-5% down.
Mortgage insurance
Conventional loans with less than 20% down require private mortgage insurance (PMI). USDA loans require an upfront guarantee fee of 1% and an annual fee of 0.35% of the loan amount.
Credit score requirements
USDA loans can be approved with a 640 credit score. Conventional loans usually need a 620 minimum.
Income limits
Your income must be below 115% of the median income for your area to qualify for a USDA loan. Conventional loans don’t have income limits.
Interest rates
Thanks to the government backing, USDA loan rates are usually a bit lower than conventional loan rates.
Eligible property types
USDA loans can only be used to purchase or refinance your primary residence. Conventional loans can also finance second homes or investment properties.
As you can see, USDA and conventional loans have distinct differences in their availability, requirements, and benefits.
Why USDA Loans Don’t Qualify as Conventional Loans
The most basic reason a USDA loan isn’t considered conventional is that it’s backed by a U.S. government agency, the USDA.
By definition, a conventional loan isn’t associated with any government organization like Fannie Mae, Freddie Mac, FHA, VA or USDA.
Beyond that core distinction, here are some other key reasons why USDA loans don’t fall under the conventional loan umbrella:
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Strict location requirements – Only rural designated areas qualify for USDA loans. Conventional loans can be used anywhere.
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Special eligibility rules – Income limits and maximum DTI ratios must be followed to get a USDA loan. Conventional loans are more flexible.
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Different mortgage insurance – USDA loans use guarantee fees while conventional loans require private mortgage insurance for lower down payments.
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Unique incentives and benefits – Such as no down payment and more flexible credit requirements. These perks aren’t offered with conventional loans.
The long list of differences clearly shows that USDA loans are in a category of their own rather than fitting under the conventional loan definition.
Pros and Cons of USDA vs. Conventional Loans
USDA and conventional loans offer different advantages and disadvantages:
USDA Loan Pros
- No down payment required
- Available with a credit score as low as 640
- Lower mortgage insurance costs than PMI
- Competitive interest rates
- Can be assumed by a new buyer when you sell
USDA Loan Cons
- Must meet location and income requirements
- Limited to primary residences only
- Slower loan approval process
- Upfront and annual guarantee fees
Conventional Loan Pros
- Easier to qualify based on credit score and income
- No geographic restrictions
- Can be used for primary residence, second home or investment property
Conventional Loan Cons
- Typically requires private mortgage insurance if less than 20% down
- Minimum 3-5% down payment required
- Must meet debt-to-income ratio requirements
The Bottom Line
While both are mortgage loans issued by private lenders, USDA loans and conventional loans have distinct differences that put them in separate categories.
The government backing, rural location requirements, and special benefits like no down payment make USDA loans a unique loan program, not a subset of conventional loans.
But both USDA and conventional loans have their own pros and cons for different financial situations. Be sure to explore and compare your options to find the best mortgage loan for buying your dream home!
Conventional loan limits explained
We noted earlier that USDA Guaranteed Loans do not have loan limits, but conventional conforming loans do. That said, you can likely get a larger conforming loan than with USDA due to the formerâs income limit.
In [loan_year], conventional loan limits are [loan_limit agency=fhfa units=1 type=standard] nationwide, and higher in many areas. USDA loans above $400,000 are few and far between thanks to income limits that top out around $100,000 per year even in expensive locales.
So itâs worth understanding a bit about conforming loan limits and how they apply to your home purchase.
Each year, the Federal Housing Finance Agency (FHFA) sets loan limits throughout the country based on the median home prices in a given area.
So home shoppers in New York City, Denver, Los Angeles, or Seattle can borrow more than shoppers in, say, Keith County, Nebraska, or Coconino County, Arizona.
To borrow more than the allowed loan limit in your area, youâd need a non-conforming or jumbo loan, which tends to require more money down and a higher credit score.
Property typeContiguous States; Washington, D.C. & Puerto RicoHigh-cost areas, Hawaii, Alaska, Guam & the U.S. Virgin IslandsSingle-family home [loan_limit agency=fhfa units=1 type=standard][loan_limit agency=fhfa units=1 type=high-cost]Duplex[loan_limit agency=fhfa units=2 type=standard][loan_limit agency=fhfa units=2 type=high-cost]Triplex[loan_limit agency=fhfa units=3 type=standard][loan_limit agency=fhfa units=3 type=high-cost]Fourplex[loan_limit agency=fhfa units=4 type=standard][loan_limit agency=fhfa units=4 type=high-cost]
Some countiesâ loan limits fall between the annual minimum and maximum limits shown above.
In Monterey County, California in 2022, for example, a conforming loan on a single-family home can go as high as $854,450. In Fairfield County, Connecticut, the limit in 2022 is $695,750.
USDA loans require no money down, though you can put money down if you donât receive an approval at zero down. Doing so may help you get approved, since thereâs less risk to the lender.
Conventional loans require at least 3% down, and you may need to put down more than to get a good interest rate. Hereâs what that might look like depending on your purchase price.
Home price3% down10% down20% down$180,000$5,400$18,000$36,000$200,000$6,000$20,000$40,000$250,000$7,500$25,000$50,000$300,000$9,000$30,000$60,000
The higher the home price, the more money youâd need to put down on a conventional loan. With a USDA Guaranteed Loan, a loan of any amount requires no down payment.
Since a USDA loan can get you into a home with less money out of your pocket, thereâs got to be a catch, right?
USDA loan mortgage insurance vs. conventional PMI
There is one, kind of. USDA loans require an upfront mortgage insurance fee of 1%, which you may be able to roll into your loan, and an annual fee of 0.35%.Â
On a $250,000 home, these fees would be $2,500 at closing and about $900 in annual premiums during the first year. As your loan balance goes down, the annual fee would decrease, too, as it would be recalculated every year.
Conventional loans require mortgage insurance as well, if you put down less than 20%. Youâd owe private mortgage insurance (PMI), which gets broken down into your monthly mortgage payment, until you reach 20% home equity. PMI could cost anywhere from 0.5% to 2% of your loan amount each year, paid in 1/12 installments with each payment.
This is where USDA might save you some money. On a $300,000 loan amount, conventional PMI at 1% annually will cost about $160 more per month compared to USDA mortgage insurance.
The USDA mortgage insurance requirement remains in place for the life of the loan, whereas the conventional requirement ends at 20%. But you can refinance a USDA loan to a conventional loan when you have 20% equity, so you can take advantage of low upfront costs on the USDA loan and the conventional mortgageâs more attractive mortgage insurance rules.
Just keep in mind that a refinance could cost thousands in closing costs. If you want to ditch mortgage insurance someday without a refinance, choose conventional.
You can use a conventional loan for many property types and uses. Single-family residences, 2-4 unit homes, condos, and townhomes are fair game. You can also finance a vacation or second home with a conventional loan.
USDA loans are designed to finance your primary residence, and it must be a single-family home. Unlike conventional, FHA and VA loans, you cannot buy a multifamily home with a USDA loan.
The USDA also has a few property guidelines you should know about:
- Property size: Home must be between 400 and 2,000-square-feet
- Utilities: Plumbing and electrical systems must work properly and the home must have access to water and wastewater services
- Property use: You canât buy a property with lots of acreage that could be subdivided or leased to a business or industry
The USDA also mandates that the homes it insures are âmodest and residential in nature.â
For a USDA loan to be approved, the home youâre buying must meet strict property requirements. Most of the time, the appraisal and approval process goes smoothly.
After all, most people who are shopping for a primary residence donât want homes that are not structurally safe. Â
Still, navigating the USDA approval process may take longer when compared to a conventional loan approval if the appraiser flags something for repair before the loan can close.
The USDA must also sign off on your application before your lender can finalize the loan, so it may take longer to close on a home with a USDA loan than a conventional mortgage.
What’s The Difference Between a Conventional Loan and a USDA Loan?
FAQ
What is the difference between USDA and conventional?
What type of mortgage is USDA?
What is considered a conventional loan?
What is the difference between FHA and USDA 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.
What is a USDA loan?
A USDA loan is a zero-down-payment mortgage option backed by the United States Department of Agriculture (USDA).
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.
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.