As a first-time homebuyer, you may feel overwhelmed when trying to choose between a USDA home loan and an FHA home loan. Both are government-backed mortgage programs aimed at helping low-to-moderate income buyers and those in rural areas achieve homeownership. But each program has distinct eligibility requirements, loan limits, and other key differences you’ll want to understand before applying.
In this comprehensive guide we’ll compare USDA vs. FHA loans to help you determine which is the better fit based on your financial situation home preferences, and goals as a buyer.
Overview of USDA and FHA Loans
First let’s look at how USDA and FHA loans stack up at a high level
USDA Loans
- Backed by U.S. Department of Agriculture
- For low-to-moderate income buyers in rural areas
- No down payment required
- Fixed interest rate and term
- Lower mortgage insurance costs
- Income limits apply
FHA Loans
- Backed by Federal Housing Administration
- Available nationwide
- 3.5% minimum down payment
- Fixed interest rate and term
- Higher mortgage insurance costs
- No income limits
Now let’s take a deeper dive into the key differences between these two popular mortgage loan programs.
Eligibility and Underwriting
When comparing USDA vs FHA loans, eligibility and underwriting requirements are a major consideration.
Locations
The biggest difference is that USDA loans can only be used to purchase homes in designated rural areas. These are outside major metropolitan zones and lack the infrastructure and amenities of urban living.
FHA loans have no geographic restrictions. You can use an FHA loan to buy a home anywhere in the U.S. and its territories.
Rural restrictions may make USDA loans unusable if you must live near an urban employment center. Always verify a property’s eligibility using USDA’s Property Eligibility Site.
Income Limits
USDA home loans have income limits based on the median income in your county. Limits range from 80-115% of area median income depending on household size and location. You can check income caps for your county using USDA’s Income and Property Eligibility tool.
FHA loans have no income restrictions. Regardless of your income, you can qualify for an FHA loan if you meet all other underwriting criteria.
Credit Score Requirements
The FHA allows credit scores as low as 580 with a minimum 3.5% down payment. USDA typically requires a minimum 640 FICO score.
If your credit score falls below 640, the USDA will manually underwrite your loan rather than using automated underwriting. But approvals on manually-underwritten USDA loans are harder to obtain.
Debt-to-Income Ratio
Your debt-to-income (DTI) ratio compares your total monthly debt payments to your gross monthly income. Most lenders limit DTIs to around 43%.
But FHA loans allow DTIs up to 55% with proper compensating factors like solid assets, significant cash reserves, or other signs of sound finances.
Higher DTI allowances increase your homebuying budget and loan eligibility. The USDA isn’t as flexible, capping DTIs at 41% unless you have strong compensating factors.
Down Payments
A major benefit of USDA loans is the zero down payment requirement. You can finance 100% of the appraised home value.
FHA also allows low down payments, but requires at least 3.5% down. So FHA buyers need some cash savings, while USDA borrowers can truly put nothing down.
Loan Limits
When it comes to maximum loan amounts, FHA loans have set lending limits that vary by county. Most areas have FHA limits up to $420,680 for single-family homes. Look up your county’s FHA mortgage limits here.
USDA loans don’t have published limits. The maximum loan amount is based on your repayment ability and the appraised value of modest, moderately-priced homes in your area. Luxury properties don’t qualify.
Mortgage Insurance
Both programs require mortgage insurance:
- USDA Loans: 1% upfront guarantee fee + 0.35% annual fee
- FHA Loans: 1.75% upfront MIP + 0.45% to 1.05% annual MIP
USDA mortgage insurance lasts the life of the loan. FHA MIP lasts 11 years if you put down 10% or more. Otherwise it too lasts the full loan term.
The only way to remove mortgage insurance is refinancing once you reach 20% home equity. But USDA’s lower rates often make its lifetime insurance cheaper than 11 years of FHA MIP.
Interest Rates
Thanks to government backing, USDA and FHA loans often have lower interest rates than conventional loans. Borrowers with lower credit scores benefit the most.
USDA rates are set quarterly by the agency based on current market rates. FHA rates vary by lender. FHA borrowers with higher credit have access to even lower rates.
Overall, both programs offer competitive interest rates ideal for first-time buyers.
Pros and Cons of USDA vs. FHA Loans
| Pros | Cons | |
|---|---|---|
| USDA Loans | – Zero downpayment <br>- Lowest mortgage insurance costs <br>- Below-market interest rates | – Limited to rural areas <br>- Income caps apply <br>- Manual underwriting if credit < 640 |
| FHA Loans | – Available nationwide<br>- Minimum 3.5% down <br>- Low credit score requirements <br>- Higher DTI allowances | – Must put 3.5% down <br>- Higher mortgage insurance rates |
Which Loan Is Right For You?
If buying in a rural location, USDA loans are a top contender thanks to ultra-low costs and maximum affordability. Just be sure you meet income limits.
FHA loans shine if you need flexibility on credit or existing debts. Since they are accessible everywhere, FHA loans also suit buyers needing to live near metro areas.
To choose between USDA vs FHA, think about your must-have home location, target budget, credit score, income, debts, and ideal monthly payment. Discuss your specific scenario with a lender to determine if USDA or FHA better fits your home loan needs.
Pro: Zero down payment required
USDA loans require no down payment. You may finance up to 100% of the property value, which, sometimes, is above the home’s purchase price. In these cases, the buyer can finance closing costs.
For example, say you make an offer on a home for $200,000. The lender’s official appraisal report states the home is worth $205,000. The buyer can open a USDA loan for the full value, as long as the excess funds are applied to closing costs such as the title report, loan origination fees, homeowner’s insurance, and prepaying property taxes and homeowner’s insurance.
So, in the end, USDA borrowers could get into a home with close to nothing out of pocket.
With FHA, the home buyer must come up with a 3.5% down payment plus closing costs. The FHA has no guidelines stating that the loan amount can exceed the purchase price. The only way to get a zero-out-of-pocket loan with FHA is to get a substantial down payment gift, down payment assistance, or seller contributions for closing costs.
The USDA is more flexible, and buyers with little cash on hand should look into this option first.
Con: Higher mortgage insurance rates
The main downside to FHA financing is that you pay mortgage insurance premiums (MIP).
Both FHA and USDA loans require borrowers to pay mortgage insurance. So do conventional mortgage loans when buyers put less than 20% down. This is known as private mortgage insurance, or “PMI.”
All three kinds of mortgage insurance protect the lender in the event of foreclosure. USDA’s mortgage insurance rates are typically the cheapest of the three.
On the other hand, FHA loans are known for having more expensive mortgage insurance premiums. Although conventional PMI rates might actually be higher if you have a lower credit score and a small down payment.
Take a look at how mortgage insurance costs might compare for a $250,000 home with 3.5% down. The borrower in this scenario has a 640 credit score.
| USDA Mortgage Insurance (MI) | FHA Mortgage Insurance Premium (MIP) | Conventional Private Mortgage Insurance (PMI) | |
| Upfront Fee (% of loan amount) | 1.0% | 1.75% | None |
| Upfront Fee ($) | $2,400 | $4,200 | $0 |
| Annual Rate (% of loan amount) | 0.35% | 0.85% | 1.65% |
| Monthly Payment (annual rate / 12) | $70 a month | $170 a month | $330 a month |
A few things to note here:
- Upfront mortgage insurance premiums for USDA and FHA can be rolled into the loan amount
- The annual FHA MIP rate drops to 0.80% if you put at least 5% down
- Conventional PMI rates can drop steeply when you have a higher credit score
The other big difference when it comes to mortgage insurance is that conventional PMI can be canceled once a homeowner has at least 20% equity.
By contrast, USDA mortgage insurance lasts the life of the loan. So does FHA mortgage insurance, unless you put at least 10% down. In that case, MIP lasts 11 years. While this might seem like a deal-breaker, even homeowners with “permanent” mortgage insurance aren’t stuck with it forever.
Those with FHA and USDA loans may be able to refinance into a conventional loan with no PMI once they reach 20% equity in the home. So, if you have a credit score in the low 600s and PMI rates are super high, don’t let the fact that PMI is cancelable sway you. An FHA or USDA loan could still be cheaper in the long run.
Are USDA or FHA Loans Better?
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.
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?
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.
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.