Among the many mortgage vehicles that can match your expectations, financial situation, and budget, two deserve special mention: USDA and conventional loans.
USDA loans are for people who want to live in suburban and rural areas. They have favorable terms and lower interest rates, making them affordable to low- and middle-income people.Â
On the other hand, conventional loans are particularly interesting for people with great credit scores, as they can offer low interest rates and have no geographical limitations on where their home can be.
For more information about which option is right for you, check out the handy USDA loan vs conventional loan guide below.Â
About USDA Loans
USDA loans are designed to promote homeownership in rural and suburban areas. These loans are an ideal choice option for eligible buyers, particularly those with lower incomes or limited savings for a down payment. If you can live in an area that is slightly removed from city centers, then a USDA loan could be the perfect choice for you.
One of the most important features of a USDA loan is that qualified borrowers don’t need to make a down payment. Since many first-time homebuyers struggle to save for a substantial down payment, a USDA loan helps with that. USDA loans also come with competitive interest rates, potentially lower than conventional loans.
These loans, however, have specific eligibility requirements. The property must be located in an area designated as rural by the USDA, and the borrower’s income can’t exceed certain limits, which vary by location and household size.
About Conventional Loans
Conventional loans, on the other hand, are not backed by any government agency. Instead, they are supplied by private lenders and conform to guidelines set by Fannie Mae and Freddie Mac; government-sponsored enterprises that buy and sell mortgage-backed securities.
Conventional loans are flexible. They can be used to purchase a wide variety of properties, including primary residences, second homes, and investment properties. There are no location restrictions, unlike USDA loans.
However, conventional loans require a down payment, with the standard being 20% of the home’s purchase price. While many lenders offer conventional loan options with down payments as low as 3% for qualified borrowers, putting down less than 20% usually requires private mortgage insurance (PMI), which adds to the overall cost of the loan.
Comparing USDA and Conventional Loans
Credit score requirements
The USDA requires a minimum credit score of 640. However, this requirement can be flexible, and some lenders may accept lower scores with compensating factors like savings or proof of stable income.
Credit score requirements for conventional loans are generally stricter. Most lenders require a minimum score of 620, but to qualify for the best rates and terms, a score of 740 or higher is often needed.
Debt-to-Income Ratio (DTI)
The USDA prefers a DTI of 41% or lower. In some cases, they may allow a higher DTI with compensating factors, again like savings or other sources of income. The importance of DTI is that lenders don’t want borrowers to be overwhelmed with debt.
Conventional loans typically require a DTI of 43% or lower. Some lenders, however, may accept up to 50% for borrowers with excellent credit and significant cash reserves that can mitigate the risks.
Property value limits
There is no set limit on the property value for USDA loans. However, the loan amount must fall within the income and loan limits for the area.
Conventional loans have conforming loan limits set by the Federal Housing Finance Agency, but they usually cover a wide range of home values. These limits vary by location and are adjusted annually.
Down payment requirements
One of the most important features of USDA loans is that they require no down payment for qualified borrowers. That is especially helpful for first-time buyers, who often struggle to put enough money towards a down payment.
Conventional loans require a down payment of at least 3% to 5%. To avoid private mortgage insurance, borrowers often need to put down 20% or more. A higher down payment comes with more favorable borrowing terms, as the borrower is considered more creditworthy and less risky.
Interest rates
USDA Loans often offer competitive interest rates, which can be lower than those for conventional loans, thanks to the government backing.
Interest rates for conventional loans can vary widely based on the borrower’s credit score, down payment, and other factors. Generally, they may be slightly higher than USDA loan rates.
Income limits
USDA loans have income limits that vary by location and household size. These limits ensure that the loans serve low to moderate-income households. For the year 2024, income limits for USDA loans stand at $112,450 for 1-4 member households. These are assessed every year.
There are no income limits for conventional loans. However, income is an important factor that determines how much money a prospective homebuyer can borrow and how much ‘home’ they qualify for.
Geographical limits
USDA loans are limited to properties in areas designated as rural by the USDA. This includes many suburban areas on the outskirts of cities but not city centers.
There are no geographical restrictions for conventional loans. They can be used to purchase properties in urban, suburban, or rural areas.
Mortgage insurance
USDA loans require an upfront guarantee fee and an annual fee, which are similar to mortgage insurance but often lower than conventional loan PMI.
Private Mortgage Insurance (PMI) is required for conventional loans with a down payment of less than 20%. PMI can be removed once the borrower reaches 20% equity in the home.
Primary residence or investment property
USDA loans may only be used to buy a primary residence. The home you buy with a USDA loan can only be used by your household and may not be rented out for a certain period.
Conventional loans can be used to buy a holiday home, an investment home, or any other type of home, as the use of the property is not limited.
Making Your Decision
Both USDA and conventional loans come with advantages depending on your financial situation and homeownership goals.
USDA loans can be an excellent option for those looking to buy in rural areas with limited funds for a down payment. Conventional loans are more flexible in terms of property location and can be a good fit for those with stronger credit profiles or the ability to make a larger down payment.
When you are about to buy your new home, think about your financial situation, the property you’re interested in, and your long-term homeownership goals. After all, the best loan for you is one that not only helps you achieve homeownership but also matches your financial capabilities and future plans. Consider your credit score, savings for a down payment, desired property location, and income level. Also, compare the total costs of each loan option, including interest rates, mortgage insurance, and closing costs.
A mortgage professional from Society Mortgage can provide personalized advice based on your financial and personal circumstances. So, contact us if you are thinking of buying a home, and one of our Loan Officers will explain all the mortgage options available to you and help you choose the one that best fits your needs. Call us today and get started on your home-owning journey!
Frequently Asked Questions
Is a USDA loan better than a conventional loan?
USDA loans are the perfect choice for first-time homebuyers in rural and suburban areas. Thanks to their favorable terms, they are particularly affordable to low and middle-income buyers. On the other hand, conventional loans are flexible, have no location restrictions, and can be used to purchase a wide variety of properties, including primary residences, second homes, and investment properties.Â
Do USDA loans have lower interest rates?
Compared to conventional loans, USDA loans usually offer lower interest rates because they are backed by the US government, which reduces the lender’s risk. This makes them more affordable for borrowers, especially those with lower credit scores or limited savings.Â
Is a USDA loan a conventional loan?
A USDA loan is not a conventional loan. USDA loans, backed by the United States Department of Agriculture, are designed to promote homeownership in rural and suburban areas. Conventional loans, on the other hand, are supplied by private lenders and conform to guidelines set by Fannie Mae and Freddie Mac.
