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.
If you’re looking to buy a home in a rural or suburban area, you may be wondering whether a USDA loan or conventional mortgage is the better option. Both offer competitive interest rates and flexible qualifications, but there are some key differences to understand.
In this comprehensive guide, we’ll compare the pros and cons of USDA and conventional loans to help you determine which is better suited for your home buying needs
Overview of USDA and Conventional Loans
First, a quick overview of both loan types:
USDA Loans
- Offered by the U.S. Dept. of Agriculture
- For rural and suburban areas
- Feature zero down payment
- Backed by government
Conventional Loans
- Offered by private lenders
- For all locations
- Typically require 3-20% down
- Not government-backed
Now let’s look at how they compare across several key factors:
Down Payment Requirements
USDA Requires 0% down payment
Conventional: Requires between 3% to 20% down.
The #1 advantage of USDA loans is that they require zero down payment. This makes them extremely affordable for buyers who don’t have tens of thousands saved up for a down payment. With a conventional loan, you’ll need at least 3% down, and ideally 20% down to avoid private mortgage insurance.
Winner: USDA
Interest Rates
USDA: Around 0.25% to 0.5% lower than conventional loans.
Conventional: Varies based on market rates and borrower criteria.
Thanks to their government backing, USDA loans can offer interest rates slightly below conventional mortgage rates. For example, if conventional loans are at 5%, USDA may be around 4.5% to 4.75%. The lower rate saves money each month and over the life of the loan.
Winner: USDA
Rural Location Requirements
USDA: Only available in USDA-designated rural and suburban areas.
Conventional: Available in any location – urban, suburban, or rural.
USDA loans are limited to rural areas and some suburban counties, while conventional loans can be used anywhere. If your home doesn’t fall within USDA’s eligible areas, a conventional loan may be your only option.
Winner: Conventional
Loan Size Limits
USDA: No explicit limits, but effectively capped based on income limits.
Conventional: Up to $650,000 for most homes, higher for costly areas.
Conventional loans allow larger mortgage amounts, up to $650,000 in most places. USDA loans are limited based on your income – the maximum typically works out to $250k to $350k. If you need a jumbo loan, conventional is likely better.
Winner: Conventional
Credit Score Requirements
USDA: 640 minimum credit score.
Conventional: 620 minimum credit score.
USDA loans allow a slightly lower minimum credit score of 640 vs. 620 for conventional mortgages. This helps more buyers with poorer credit qualify. That said, a higher score is recommended for the best USDA loan rates.
Winner: USDA
Debt-to-Income Ratio Allowances
USDA: 29%/41% front/back-end DTI; up to 32%/44% with compensating factors.
Conventional: Typically 43% or 50% total DTI.
USDA loans are stricter on debt-to-income ratios than conventional loans. You need to keep your ratios lower to qualify for USDA financing. If you have high existing debts, a conventional loan may work better.
Winner: Conventional
Mortgage Insurance Costs
USDA: 1% upfront fee + 0.35% annual mortgage insurance rate.
Conventional: No upfront fee. Monthly mortgage insurance rate varies.
USDA loans charge a 1% upfront guarantee fee, rolled into the loan amount. They also charge 0.35% of the loan amount per year for mortgage insurance. This works out to around $29/month per $100k borrowed.
Conventional loans don’t have an upfront fee, but their monthly mortgage insurance can range widely from $23 to $150 per $100k depending on your down payment and credit score. Overall, USDA mortgage insurance costs are very competitive.
Winner: USDA
Ease of Refinancing
USDA: Streamlined refinance available for current USDA loan holders.
Conventional: Must re-apply and meet full underwriting criteria to refinance.
Refinancing is much easier with a USDA loan. You can use their Streamlined Refinance program which simplifies the process for existing USDA borrowers. With conventional loans, you must submit a full application and meet all underwriting requirements again.
Winner: USDA
Who Is Each Loan Best For?
USDA loans are ideal for:
- First-time home buyers
- Low down payment buyers
- Lower credit score borrowers
- Rural or suburban locations
Conventional loans are better for:
- Jumbo loan amounts
- High DTIs
- Urban locations
- Quicker closings
The Bottom Line
While conventional loans work in more areas and offer higher loan amounts, USDA loans provide two major advantages:
- Zero down payment requirement
- Lower interest rates
These features make USDA an excellent option if you qualify based on your location and income. Be sure to check your USDA eligibility and compare quotes from lenders on both loan types before deciding which to apply for.
FAQs About USDA vs Conventional Loans
Can I get a USDA loan for a manufactured home?
Yes, USDA loans work for manufactured and modular homes as long as they meet program requirements. You can use a USDA construction loan to purchase land and place a manufactured home on it.
What credit score is needed for a conventional loan?
The minimum credit score for a conventional loan is 620. But scores of at least 680+ are generally recommended for the best interest rates from lenders.
Do USDA loans have prepayment penalties?
No, you can pay off a USDA loan early with no prepayment penalty. This is the same as conventional loans which cannot charge prepayment penalties.
What is the maximum income for a USDA loan?
There is no fixed maximum income limit across the US. Income cutoffs vary by location based on the median income of each area. In expensive areas the limit may be over $100k, while in lower-cost areas it may be $60k.
Can I use a USDA loan to refinance a conventional loan?
Yes, you can refinance from a conventional to USDA loan if your home is located in a USDA-eligible area and your household income is within USDA limits for that county. This allows you to take advantage of USDA benefits like lower rates and easier refinancing.
Which has higher closing costs, USDA or conventional?
Closing costs are generally similar between USDA and conventional loans. Origination and other lender fees are capped to similar amounts for both loan types. The main differences are the USDA 1% upfront guarantee fee and lower down payment needed.
Advantages of Conventional Loans vs. USDA Loans
Conventional loans offer several advantages over USDA loans, making them a preferred choice for some borrowers:
- Qualifying for a conventional loan depends primarily on the borrower’s financial situation, rather than set eligibility criteria like that of USDA loans.
- There are no restrictions on the type or location of the property for conventional loans. Borrowers are not limited to purchasing a single-family home that serves as their primary residence when using a conventional loan over a USDA loan.
- While conventional loans have a set minimum credit score of 620, this minimum falls below the benchmark credit score of 640 that many USDA lenders look for.
- For most conventional loans, there is no maximum income limit for potential borrowers.
- However, keep in mind that HomeReady and Home Possible conventional loans are restricted to borrowers making less than or equal to 80% of their local area median income.
- Conventional loans offer the highest maximum seller concessions of 9%. However, keep in mind that borrowers must put at least 25% down to qualify for this maximum limit.
- With a down payment between 10 and 25%, borrowers qualify for up to 6% maximum seller concessions, while those borrowers with a down payment of less than 10% can negotiate up to 3% for seller concessions.
Disadvantages of FHA Loans vs. USDA Loans
However, FHA loans also have their drawbacks when compared to USDA loans:
- FHA loans require a minimum down payment of 3.5%, which can be a significant upfront cost for some borrowers.
- With a 3.5% down payment, FHA loans require a minimum credit score of 580. Borrowers falling below this credit requirement will likely need to increase their down payment to qualify for an FHA loan.
- FHA loans have a maximum loan limit that varies by county, which may limit borrowing capacity in high-cost areas. This loan limit starts at $498,257 but can reach $1,149,825, depending on the location of the property.
- FHA loans require a mortgage insurance premium (MIP) both up-front and on an annual basis throughout the life of the loan.
Ultimately, the choice between USDA loans and FHA loans will depend on individual circumstances, such as the desired property location, credit score and financial capacity of the potential borrower. Whether its the convenience of FHA loans or the benefits of USDA loans, finding the right fit will set the foundation for a successful and rewarding homeownership journey.