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Buying a home can be an expensive pursuit. Fortunately, there are strategies you can take advantage of to lower your home buying costs.
If you are an aspiring home buyer with a low- to moderate-income, you should explore the different loan options at your disposal. If you’re struggling to qualify for a conventional mortgage because of credit or savings issues, you may be able to make purchasing a home more affordable with a USDA loan or an FHA loan.
To understand whether a USDA or FHA loan might work best for you, we’ll look at the differences between the two loans. Knowing how they work and who they help could be the key that finally unlocks the doors to homeownership.
USDA vs. FHA Loans: What Are They?
USDA loans and FHA loans are mortgages backed by the federal government. Although the loans are insured by the federal government, you apply for them with private lenders. The federal government promises lenders they’ll cover a portion of these loans if borrowers can’t make their monthly payments (aka default). Because of this promise, borrowers with lower credit scores and incomes or higher debt-to-income (DTI) ratios might find it easier to qualify for government-backed mortgages.
The Difference Between USDA Loans and FHA Loans
USDA and FHA loans are federally backed loans, but each is different in critical ways. First, each loan is managed by a different federal agency.
USDA loans are backed by the U.S. Department of Agriculture (USDA) and offer mortgages to low- to moderate-income borrowers who want to buy homes in qualifying rural areas.
USDA loans typically have stricter eligibility requirements. For example, you can’t use a USDA loan to buy a home in a densely-populated urban area. And you would be disqualified for the loan if your income was higher than the average income in your county. USDA loans usually take a little longer to process because the loan applications are reviewed (read: underwritten) by the USDA and your lender.
FHA loans are regulated by the Federal Housing Administration (FHA), a branch of the Department of Housing and Urban Development (HUD). While FHA loans don’t limit where you can buy a house, they do set maximum lending amounts for borrowers. FHA loans are generally designed for first-time home buyers with lower credit scores or minimal savings.
When looking at USDA loans vs. FHA loans, they each have different eligibility requirements. If you don’t qualify for one loan, you may qualify for the other.
USDA loans are for home buyers in rural areas, but this isn’t the only requirement you’ll need to consider.
- Credit score: While the USDA doesn’t set a minimum credit score requirement, your lender may set one. Lenders typically require a credit score of 640 or higher. If your credit falls within this range, the USDA will provide automatic underwriting, speeding up the time it takes to get to closing.
- Income: USDA loans are available to lower- to moderate-income borrowers. Typically, a household can’t earn more than 115% of the average income in the area to qualify. Use the USDA’s income eligibility tool to see the income requirement in your state and county.
- Debt-to-income (DTI) ratio: Your DTI ratio must be 41% or less to qualify for a USDA loan.
- Location: The property must be in an eligible rural area. You can use the USDA’s eligibility map to determine whether a property is in a qualifying area.
- Type of property: A USDA loan allows a borrower to purchase a single-family home they intend to use as a primary residence.
- Maximum purchase price: There is no maximum purchase price for a home financed with a USDA loan. But to qualify, a borrower must submit proof that they can afford the home.
FHA loan requirements tend to be more relaxed than USDA loan requirements.
- Credit score: The minimum credit score for an FHA loan is 500. It’s much lower than 620, which is the score required for most conventional home loans. However, a 580 credit score is required to qualify for FHA’s lowest down payment of 3.5%. If your credit score falls below 580, you’ll need to make a 10% down payment.
- Income: The FHA doesn’t set any minimum or maximum income requirements for FHA loans. But you must provide proof of employment and income to your lender.
- Debt-to-income (DTI) ratio: FHA loans require a DTI ratio that isn’t above 43%.
- Location: To qualify for an FHA loan, the home must be in the U.S. or a U.S. territory (like Puerto Rico or U.S. Virgin Islands).
- Type of property: FHA loans apply to single-family homes, townhouses, condos and multifamily homes with up to 4 units. You must move into the property within 60 days of closing and use the property as your primary residence for at least 1 year.
- Maximum purchase price: While there are no maximum purchase prices with FHA loans, there are limits on the amount you can borrow. As of 2023, the FHA loan limit – which varies by county – ranges between $472,030 and $1,089.300 for a single-family home. You can see the borrowing limits in your area on the HUD website.
Getting an FHA loan is the better option if you don’t want to be limited by location. As long as the home is in the U.S. or a U.S. territory, it qualifies for an FHA loan.
USDA loans must be located in a USDA-designated rural area to qualify.
The approval process
FHA and USDA loans require the standard documents you’d provide for conventional mortgage approval, including government-issued ID, pay stubs and tax returns. Depending on the loan and your lender, you may need to submit additional paperwork with your application.
Consider getting preapproved for your FHA or USDA loan to jump-start the underwriting process. Even with a preapproved loan, it could take anywhere from 30 to 45 days to process the loan and close on the home. Remember, it usually takes a little longer to close on USDA loans because the loans are underwritten by the USDA and your lender.
The USDA and FHA require the home to be appraised to ensure you’re buying it at fair market value – but USDA loans don’t require a home inspection.
FHA loans also have unique requirements that may lengthen the process. Your lender will require a home appraisal and inspection from an FHA-approved appraiser before closing. After you close, you must move into the home within 60 days and use it as your primary residence for at least 1 year. Failing to meet these two requirements could land you in legal trouble.
USDA and FHA loans are designed to help borrowers who might struggle with the down payment requirement for conventional loans. USDA loans don’t have a down payment requirement. But if you make a down payment, you’ll likely lower your monthly mortgage payments and the loan’s interest rate.
With an FHA loan, if your credit score is between 500 and 579, you’ll need to make a down payment that’s at least 10% of the home’s purchase price. If your credit score is 580 or above, the FHA requires at least a 3.5% down payment. Like USDA loans, making a higher down payment could unlock lower interest rates and monthly payments.
With a conventional loan, lenders typically require monthly mortgage insurance if you don’t make a 20% down payment. USDA loans don’t require borrowers to pay private mortgage insurance (PMI), but borrowers must pay guarantee fees. These fees include a one-time, upfront guarantee fee that equals 1% of the total loan amount and an annual fee equal to 0.35% of the loan amount.
FHA loan borrowers must pay a mortgage insurance premium (MIP). The upfront fee equals 1.75% of your loan amount. And you’ll pay an annual premium that ranges from 0.45% to 1.05% of your loan amount.
USDA and FHA loan interest rates are competitive compared to conventional loan rates. However, factors like your credit score, income and DTI ratio can affect how much you pay in interest. As of October 2022, the USDA loan interest rate for borrowers is 3.5%. FHA loan interest rates tend to be higher and fluctuate more than USDA rates, but they are still more competitive than most conventional home loans.
Is a USDA or FHA Loan Better for Me?
A USDA loan is likely your best option if you want a home in a rural area and your income qualifies you for the loan. If you don’t qualify for a conventional loan and want to save on your upfront home buying expenses, an FHA loan is a great option that puts fewer limits on where you can purchase a home.
In either case, these government-backed loans can help you overcome financial obstacles and finance your dream home.
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The Short Version
- USDA loans and FHA loans are mortgages backed by the federal government
- While FHA loans don’t set limits on where you can buy a house, they do set maximum lending amounts for borrowers
- USDA loans are for home buyers in rural areas, but this isn’t the only requirement you’ll need to consider
U.S. Department of Housing and Urban Development. “FHA Mortgage Limits.” Retrieved January 2023 from https://www.hud.gov/program_offices/housing/sfh/lender/origination/mortgage_limits
U.S. Department of Agriculture. “Single Family Housing Direct Home Loans | Rural Development.” Retrieved October 2022 from https://www.rd.usda.gov/programs-services/single-family-housing-programs/single-family-housing-direct-home-loans