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USDA vs. FHA Loans: What’s the Difference?

Reviewed by: David Naimey

Approved by: Chad Turner

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USDA and FHA loans offer borrowing terms for people who might find it hard to qualify for a conventional mortgage to buy a home. FHA and USDA loans are geared toward people with low incomes and less-than-stellar credit scores who might not be able to access the property ladder with a conventional loan. 

USDA and FHA loans also offer lower mortgage rates and lower down payments to make it even easier for people who struggle financially to achieve their dream of home ownership. 

Having said that, USDA and FHA loans differ between them as to what type of home they finance and other qualifying criteria. Each loan type has pros and cons to take into consideration.

What Is a USDA Loan?

A USDA loan is backed by the United States Department of Agriculture. Since it’s geared toward reviving rural development, it has strict location requirements. To qualify for a USDA home loan, the home must be located in a rural area and cover specific safety and living standards. 

What Is an FHA Loan?

An FHA loan is backed by the Department of Housing and has been designed to offer people with below-average credit scores the opportunity to qualify for a mortgage. These loans are offered by banks and mortgage lenders and have the backing of the Department of Housing if the lender fails to repay the mortgage. 

Common Features of USDA and FHA Loans

Both are backed by government agencies

USDA loans are backed by the Department of Agriculture; FHA loans are backed by the Federal Housing Administration. The main purpose of these types of mortgages is to help people who can’t qualify for conventional loans to access home ownership on reachable terms. In both cases, the property needs to be the primary residence of the borrower rather than an investment property.

Favorable terms

Although USDA and FHA loans have different requirements, their main goal is to minimize down payments, lower interest rates and provide mortgages for people with average and below-average incomes. 

Fixed interest rate

USDA and FHA loans come with fixed interest rates. This helps borrowers plan their finances as they know exactly how much they are going to pay every month without any unexpected interest rate hikes. 

Flexible underwriting standards

Both types of home loans offer more flexible underwriting standards for buying a home than many conventional loans. This flexibility includes considerations for lower credit scores and higher debt-to-income ratios, making it easier for individuals with varying financial backgrounds to qualify.

Potential for low down payments

Down payments can be a significant obstacle to a first-time home buyer. Mortgages with a small down payment requirement make home ownership affordable. 

While USDA home loans are notable for offering 100% financing (no down payment) to buy a house, FHA loans also offer a low down payment option, as low as 3.5% of the purchase price for borrowers with a credit score of 580 or higher. This feature makes both mortgage loan types particularly attractive to first-time homebuyers or those with limited savings for a down payment.

Differences Between FHA and USDA Loans

Eligibility requirements

USDA Loans are specifically designed to encourage homeownership in rural areas. To qualify, the property must be located in a USDA-eligible area. While large swathes qualify as rural areas, urban areas do not. People applying for a USDA loan must find properties located in rural locations. 

FHA eligibility criteria, on the other hand, do not include any such geographic restrictions. They are available for both rural and urban development areas. FHA loans are available to homebuyers who meet the FHA’s income and credit requirements, making them a more accessible option for a wider range of borrowers, including those in urban and suburban areas.

Income criteria

USDA loans are specifically designed to assist low- to moderate-income individuals. Thus, there are maximum USDA income limits. These limits vary depending on the geographic area and are adjusted for the size of the household. Typically, the household income should not exceed 115% of the area’s median household income.

Unlike USDA loans, FHA loans do not have any maximum income limits. This makes them accessible to a broader range of income levels. The primary concern is to determine the borrower’s ability to make the monthly mortgage payment; not the total income level compared to the median income.

Down payment

USDA Loans offer 100% financing, meaning no down payment is required. This feature is particularly helpful for borrowers who may not have the funds for a traditional down payment, especially first-time home buyers who can’t tap into the equity of previous home ownership.

With the FHA loan program, the difference is that they require a down payment, although this can be as low as 3.5% if the borrower’s credit score is 580 or higher. Borrowers with a lower credit score between 500 and 579 must put down 10% of the appraised value of the property.

Mortgage insurance

USDA Loans require borrowers to pay an upfront guarantee fee, paid at closing, which is usually around 1%. You are also required to pay an annual fee on the remaining balance, which stands at 0.35%. This is added to the monthly debt payments. These fees are generally lower than the mortgage insurance premiums for FHA loans. 

FHA Loans also require an upfront mortgage insurance premium, which stands at 1.75%. They also ask for an ongoing annual premium, typically for the life of the loan (unless the borrower chooses to refinance to a non-FHA loan). FHA mortgage loans thus require higher monthly mortgage insurance premiums compared to USDA loans.

Credit score requirements

USDA Loans often have slightly higher credit score requirements compared to FHA loans. While specific requirements can vary by lender, USDA loans typically require a credit score of around 640.

FHA Loans have more lenient credit score requirements. Borrowers can qualify with a score as low as 500, though better terms are offered to those with a score of 580 or higher. A higher credit score means you can make a lower down payment. 

Loan limits

USDA Loans do not have a loan limit. Instead, the borrower’s ability to repay the loan determines the loan amount they can get. This will depend on income, debt, assets, and credit history.

FHA Loans have maximum loan limits that vary by county and are adjusted annually. These limits can restrict the amount a borrower is eligible to finance through an FHA loan, which makes it more difficult to buy properties in high-cost areas.

Property standards

One of the cons of USDA loans is that they have strict requirements regarding the condition and quality that the property must meet. The home must meet certain USDA standards and be deemed habitable and safe.

FHA Loans also have property requirements, focusing on safety, security, and structural integrity. FHA standards are primarily concerned with ensuring the health and safety of the occupants.

Purpose of the loan

USDA Loans are exclusively for purchasing primary residences in eligible rural areas.

FHA Loans can be used for purchasing primary residences, refinancing, and even certain home repairs (through FHA 203(k) rehabilitation loans).

Neither loan covers second homes or investment properties. In both cases, homebuyers must personally occupy the single-family home as their primary residence.

Society Mortgage for Your USDA or FHA Loan

If you feel that FHA and USDA loans are the best types of mortgage for you, contact Society Mortgage. Our loan officers will give you all the necessary information on the advantages and disadvantages of each type of loan and will guide you to make the right choice for you. Society Mortgage is an Equal Housing Opportunity lender. Call us today to find out more about our services.

Frequently Asked Questions

What are the key differences in income requirements for FHA vs USDA loans?

USDA loan requirements are designed for low- to moderate-income individuals and have specific income limits that vary by region and household size. FHA loans, on the other hand, don’t have maximum income limits, focusing instead on the borrower’s debt-to-income ratio.

Do USDA loans require mortgage insurance?

Yes, USDA loans require an upfront fee as a guarantee. You also have an annual fee, which serves a similar purpose to mortgage insurance. These fees are typically lower than FHA mortgage insurance premiums, though.

Is a down payment required for an FHA loan?

Yes, FHA loans require a down payment. The minimum down payment is 3.5% for borrowers with a minimum credit score of 580, and 10% for those with a credit score between 500 and 579.

How does my credit score affect my loan application eligibility for these loans?

For USDA loans, a minimum credit score of around 640 is generally preferred, although exceptions can be made. For FHA loans, borrowers can qualify with a credit score as low as 500, though it is easier to get a loan with better terms with scores of 580 or higher.

What are the closing costs for an FHA or USDA loan?

Both USDA and FHA loans come with closing costs that account for 3 to 6 percent of the home’s value and include upfront mortgage insurance premiums (MIP), lender fees, prepaid property taxes, etc. The closing costs may differ depending on the lender, the property, the seller, etc. A closing disclosure lists them in detail.

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