Is a USDA Loan a Conventional Loan?

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.

Many homebuyers looking to purchase a property in a rural area wonder if a USDA loan is considered a conventional loan With multiple mortgage options available, it can get confusing understanding the differences between loan types. In this article, we’ll clarify whether USDA loans are conventional and highlight the key distinctions borrowers should know

What is a Conventional Loan?

A conventional loan refers to a mortgage that is not part of a government-backed program. The two main types of conventional loans are conforming and non-conforming loans

Conforming loans adhere to the underwriting guidelines set by Fannie Mae and Freddie Mac. These agencies purchase conforming loans from lenders and sell them to investors on the secondary mortgage market. Having this government sponsorship makes conforming loans less risky for lenders.
Non-conforming loans don’t meet the conforming standards. They may have higher loan amounts or the borrower’s situation doesn’t fit within the conforming loan criteria.

Conventional loans are the most common type of mortgage loan, financing over 90% of home purchases in the U.S.

What is a USDA Loan?

USDA loans are mortgages insured by the U.S. Department of Agriculture’s Rural Housing Service. The funds for these loans come directly from the federal government.

Some key features of USDA loans include:

Location requirements – The home must be in an eligible rural area as defined by the USDA property eligibility map. Many suburban neighborhoods qualify.
Occupancy requirements – Borrowers must use the home as their primary residence. USDA loans can’t be used for second homes or investment properties.
Income limits – Applicants’ household income must be below 115% of the median income for their area. All adult household members’ incomes are considered.
Lenient credit requirements – Minimum credit score is 640, but applicants under 640 may still qualify with good compensating factors.
No down payment – 100% financing means borrowers can get a USDA mortgage with zero down.

Is a USDA Loan Considered Conventional?

No, USDA loans are not conventional loans. They fall under the category of government-backed mortgages rather than conventional mortgages. Some key differences:

Backing – USDA loans are backed by a federal government agency, the USDA. Conventional loans lack this government guarantee.
Requirements – USDA loans have location and income limits that don’t apply to conventional loans.
Down payment – Conventional loans require a minimum 3-5% down in most cases. USDA loans offer 100% financing.
Mortgage insurance – USDA borrowers pay an upfront guarantee fee and annual fee. With a conventional loan under 20% down, you’ll owe private mortgage insurance.
Interest rates – Government backing allows USDA loans to offer competitive interest rates, though conventional rates can be lower with good credit.
Eligible properties – Conventional loans can be used for primary homes, second homes or investment properties. USDA only covers primary residences.

USDA Loan vs FHA Loan

Like USDA loans, FHA loans are government-backed mortgages aimed at low-to-moderate income borrowers. But there are some notable differences between these two programs:

Location – FHA loans can be used nationwide, while USDA loans are limited to rural areas.
Down payment – FHA requires at least 3.5% down. USDA offers 100% financing.
Mortgage insurance – FHA charges an upfront mortgage insurance premium and annual fee. USDA also has an upfront and annual guarantee fee.
Credit score – Minimum is 580 for FHA, 640 for USDA (with some exceptions).
Income limits – FHA has no income caps. USDA applicants can’t exceed local income limits.

For homebuyers in rural regions, the zero down payment and relaxed credit requirements of a USDA loan may make more sense than an FHA loan. But borrowers who don’t meet USDA criteria will likely need to pursue an FHA mortgage instead.

USDA Loan Requirements

Now that we’ve clarified USDA loans aren’t conventional, let’s look at the specific eligibility criteria for these mortgages:

Location Requirements

The home you wish to buy or refinance must be in a rural area as designated by the USDA property eligibility map. To check, simply enter the property address. Many suburban neighborhoods qualify as rural according to the USDA definitions.

Income Limits

Household income cannot exceed 115% of the median income for the area, adjusted for family size. All adult household members must have their income verified and counted. Income thresholds vary by location.

Credit Requirements

A minimum credit score of 640 is needed for streamlined USDA approval. With scores between 600-639, manual underwriting is required. Compensating factors may allow approval for borrowers with scores below 640.

Debt-to-Income Ratio

Keep your DTI below 41% to easily qualify. But ratios above 41% may be acceptable with good compensating factors. USDA looks at your entire financial picture.

Occupancy and Property Requirements

You must make the home your principal residence. USDA loans can’t be used for investment properties or second homes. Existing homes and new construction are eligible, as are single-family homes, townhouses and condos.

Down Payment and Closing Costs

No down payment is required. However, borrowers must still have funds to cover closing costs, which run 3-6% of the mortgage amount.

USDA Loan Benefits

For eligible borrowers, USDA loans can make homeownership affordable, even with limited savings. Here are some of the top benefits:

Zero down payment – USDA requires no down payment whatsoever. This removes a major hurdle many first-time buyers face.
Low interest rates – Thanks to government backing, USDA offers competitive mortgage rates to qualified applicants.
Low mortgage insurance – The 1% upfront guarantee fee and 0.35% annual fee are lower than private mortgage insurance with conventional loans.
More flexible credit – Minimum score of 640 is lower than what many conventional loans allow. Compensating factors provide more ways to get approved.
No income limits – As long as you fall under the maximum income cap for your area and loan size, there is no minimum income requirement.
Simple application – USDA has standardized underwriting requirements, so the process is straightforward for both lenders and borrowers.

For rural residents who currently rent or live with family, a USDA mortgage can be the ideal solution for breaking into homeownership. The program provides options for those who may not qualify through conventional lending channels.

USDA Loan Drawbacks

USDA mortgages have clear advantages, especially for low-income borrowers with limited savings. But these government-backed loans also come with some potential drawbacks to consider:

Strict requirements – Not everyone will meet the specific USDA criteria related to location, income and credit. Requirements tend to be more rigid than conventional loans.
Longer approval – Because USDA must also approve the loan, it takes longer to get fully approved, typically 60-90 days. Conventional loans can close in as little as 45 days.
Rural locations only – Home must be in an eligible rural area, limiting options. Conventional loans can be used in any location.
Single family only – Must be your primary residence. Conventional loans also permit second homes or investment properties.
Ongoing fees – The annual USDA guarantee fee lasts the life of the loan. With conventional loans, PMI can eventually be canceled.
Home costs – Rural areas tend to have more affordable housing prices. If you need a higher loan amount, USDA loans may not work.

As with any mortgage, you’ll want to think carefully about both the pros and cons before committing to a USDA loan. Make sure it aligns with your home buying goals and financial capabilities.

Alternatives to USDA Loans

A USDA loan is a great option if you qualify, but it’s not the only way to finance a home. What alternatives should you consider?

Conventional Loans – For buyers who don’t meet rural location or income requirements, a conventional mortgage will be the way to go. You’ll likely need a 3-20% down payment.

FHA Loans – FHA allows down payments as low as 3.5% and is available nationwide. It’s a good fallback if you don’t qualify for USDA.

VA Loans – For active duty military and veterans, VA loans offer zero down payment options without rural restrictions.

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Conventional loan eligibility requirements

Conventional loans come in several different forms, but the most common conventional loans are conforming loans, which adhere to lending guidelines set by Frannie Mae and Freddie Mac.

To qualify for a conventional loan, youâll need to meet these requirements:

Credit score: 620 or higher
Debt-to-income ratio: Determined by Automated Underwriting System
Down payment: 3%

One area in which conventional loans have USDA loans beat is flexibility. There are no income or geographic restrictions for most conventional mortgages, so you can use them to buy a home anywhere in the country. (Some 3% down conventional loans come with income limits, though.)

Conventional conforming loans are subject to loan limits, however. The conforming loan limits for a single-family home in [loan_year] range between Â [loan_limit agency=fhfa units=1 type=standard] and [loan_limit agency=fhfa units=1 type=high-cost], depending where you live.Â

Unlike USDA loans, conventional loans can finance any type of occupancy, including vacation homes and investment properties.

The USDA Guaranteed Loan program has strict income limits. Youâll qualify only if your household income falls below 115% of your areaâs median income.

The USDAâs online income calculator can give you an idea of whether youâre eligible. But donât dismiss the possibility of a USDA loan if your household income exceeds the limit at first glance.

USDA lenders calculate household income eligibility after deductions for minor children, childcare, and certain medical expenses. So while your gross income may put you above the limit, you could still qualify once your lender accounts for deductions.

Most conventional loan programs do not have income limits. However, some programs â such as Fannie Mae HomeReady and Freddie Mac HomeOne â are the exceptions. These programs allow down payments as low as 3%, but only borrowers who earn no more than 80% of their areaâs median income can qualify.

Yes, USDA loans are available only in certain areas, but you may be surprised by how many of those areas there are.

Most of the Continental U.S. meets the USDAâs definition of rural. Many suburbs within an hourâs commute of major cities qualify for USDA loans as well, so you donât have to move to a small town or sparsely populated area to get one of these loans.

Conventional loans can be used in any location; there are no geographic limits.

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 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?

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.

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.

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.

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.