USDA vs. Conventional: Which Loan Is Right for You?

Depending on where you live, you might qualify for a USDA loan. For those looking to buy a home, this begs the question: should you pursue this option instead of a conventional loan?

We’ll explain the differences between conventional and USDA mortgage loans, their requirements and the pros and cons, so you can make the choice that’s best for your situation.

Defining USDA and Conventional Loans

Most Americans don’t have the cash to buy a home outright. In fact, over 90% of home purchases use mortgage financing.^[1]

Both USDA loans and conventional loans are types of mortgages. Generally, a lender provides the money to purchase the home, and then the borrower repays the loan to the lender, plus interest.

But while both are mortgages, a USDA loan is not the same as a conventional loan.

USDA loans: These are mortgage loans insured by the U.S. government – specifically, the U.S. Department of Agriculture (USDA). They offer unique benefits, such as no required down payment, but come with strict eligibility requirements. 

Conventional loans: These mortgage loans aren’t backed by a U.S. federal agency. There are two categories of conventional loans: conforming and nonconforming.

USDA vs. Conventional Loan Eligibility Requirements

This table gives a quick overview of the different requirements for each type of loan. 

Category	USDA Loan	Conventional Loan
Property Location	Must be in an eligible rural area	No requirement
Income	Maximum limit: income can’t exceed 115% of median local income.[3]	No maximum limit, but you must prove “stable and predictable income.”[4]
Credit Score	640 and above: streamlined approval 640 and below: Possible approved, but USDA will analyze credit history[5]	Minimum 620 for fixed-rate mortgage[6]
Debt-to-Income Ratio	Proposed monthly housing expense shouldn’t exceed 29% of repayment income. Total debts shouldn’t exceed 41% of repayment income.[7]	Maximum DTI ratio is 36% of the borrower’s stable monthly income. DTI ratios up to 50% may be approved, if the borrower meets certain requirements and is underwritten through DU.[8]
Down Payment	No requirement	Minimum 5% (unless you meet specific requirements)

Location

One of the USDA’s main functions is to ensure the vitality of America’s rural communities. To qualify for a USDA mortgage, the property must be located in an eligible rural area as defined by the USDA.

Conventional loans don’t have these restrictions on location, but you’ll need to meet other eligibility requirements. 

Income

USDA loans have adjusted income limits, which vary based on where the property is located and how many members live in the home. 

For example, in Henry County, Alabama, the moderate income limit is $103,500 for households of up to 4 people, but this increases to $136,600 for houses of 5 – 8 people. These limits differ from county to county and state to state.^[3]

For conventional loans, there’s no maximum income limit. The key is to provide proof of stable income via documentation. This shows the lender that the borrower will be able to make their monthly mortgage payments. 

Credit score

Your credit score can have a big impact on whether you qualify for a given mortgage.

The critical credit score for USDA loans is 640.^[5] If your credit score is 640 or above, you’ll enter what’s known as “streamlined” credit approval and avoid manual underwriting. Because the process is more automated, it usually moves faster. 

If your credit score is under 640, you can still be approved, but your credit history will be analyzed by the USDA. They may ask you to provide alternative credit sources. This can come from creditors who don’t report to the credit bureaus or third-party sources.

Even if your score is under 640, and you can’t provide alternative proof of credit, you still might qualify for an exception to credit standards. Here are some exceptions the USDA may consider:^[5]

• Reduced shelter costs
• Temporary situation
• Benefit to the government

The process is more defined for conventional loans. With very few exceptions, you need a minimum credit score of 620 to qualify for a conventional mortgage.^[6]

Debt-to-income ratio

The most straightforward way to qualify for a USDA loan is to keep your proposed monthly housing expenses below 29% of your estimated repayment income and your total debt-to-income (DTI) ratio below 41% of your repayment income.^[7]

That said, the USDA still has the ability to grant the loan – even if the borrower’s ratios exceed these limits – if the lender determines there are strong compensating factors indicating a household has a higher repayment ability.

For a conventional loan, you should aim for a DTI ratio of under 36%. Although, you can still be approved with a ratio of up to 50% if your case file goes through DU underwriting.^[8]

Down payment

One of the biggest selling points of a USDA loan is there’s no down payment requirement. This can allow borrowers to start building equity without spending years saving for a down payment.

For a conventional loan, you’ll need a minimum of 5% down.  You can get approved for as little as 3% down if you meet specific requirements related to income and if you are a first-time home buyer. 

5% down for a $350,000 property would come to $17,500. However, if you put down less than 20%, you’ll likely have to pay private mortgage insurance (PMI). This will be added to your monthly mortgage payment.

Which Loan Is Better? 

To help you understand why each loan option might work for your situation, we’ve compiled some benefits and drawbacks. 

USDA loan pros and cons 

Conventional loan pros and cons

Tips for Choosing Between USDA and Conventional Loans

It’s one thing to have a general understanding of how these loans work. It’s another to apply this knowledge to your own financial situation. To help you get started, here are some questions to ask yourself:

• Which of these loans do I qualify for? Zero money down might sound enticing. But if you don’t live in a rural area or if you make too much money, you won’t qualify for a USDA loan.
• How much can I afford to put down? With a USDA loan, you’ll pay the guarantee fees no matter how much you put down. With a conventional loan, you won’t pay PMI if you can put 20% down. 

Two Loans Diverged in a Wood

When it comes to choosing between these loans, your circumstances should guide your choice. If you have money saved for a down payment and don’t want any restrictions on where you can live, a conventional loan is probably the better option.

That said, if you’re looking at property in a qualified rural area and make a low to moderate income, the USDA program exists to help make homeownership a reality.