USDA vs. Conventional Loans: What Are the Differences?

Written by Crystal KellyUpdated: 28th Dec 2021
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If you are in the market to buy a home in a designated rural area, you may have options on which loan will suit you best.

A USDA loan is designed for low to moderate-income earners that are purchasing in rural areas.

A conventional loan is the most popular type of mortgage, because of its flexibility and easy qualification requirements. Take a look at the differences between the two.

USDA Loan vs. Conventional Loan Overview

A USDA loan is insured and backed by the Department of Agriculture (the USDA) and can purchase a home located in a designated rural area. Many of these rural areas are just outside city limits.

These loans are funded by private lenders that are approved by the USDA. There are no down payment requirements for these loans, and flexible requirements such as credit and debt-to-income ratios make this an affordable choice.

Conventional loans are mortgages that are not a part of any government program, which gives the lenders more flexibility to qualify someone for a loan. These loans come with two options: conforming and non-conforming.

Conforming loans meet the requirements set by Freddie Mac and Fannie Mae, two private companies that follow a set of guidelines for home loans.

By adhering to these guidelines, or ‘conforming,’ the loan can be backed by Freddie Mac orFannie Mae, making the loans less risky for lenders. This, in turn, allows lenders to approve more home loans.

Non-conforming loans do not meet these same requirements. Mortgage Lenders have some room to structure these loans to suit the lender and the buyer.

USDA vs. Conventional Loan Requirements

USDA Loan Requirements

Certain requirements must be met to be approved for a USDA loan. To qualify:

  • Location: The property/home you want to buy must be in a designated rural area. Visit USDA to check the property address.
  • Income: USDA loans have income limits and restrictions. The income limit requirements vary by region; however, they increase as you get closer to metropolitan areas.
  • Citizenship: You must be a U.S. citizen, a U.S. non-citizen national, or a qualified alien.
  • Primary Residency: You must live in the home you are buying with a USDA loan, and it cannot be an investment property or 2nd home.
  • Credit: The USDA doesn’t have a minimum credit score requirement, so low credit appliers can be approved.
  • Federal Debts: If you have any federal debts such as students loans or IRS payments, you must be in good standing on those debts to qualify for the USDA loan.
  • Ability to Repay: Your monthly mortgage payment (for the property you want to buy) cannot exceed 29% of your monthly income. The total debt payments you have (including the new mortgage payment) cannot exceed 41% of your income. If you have a savings account or a high credit score, they can decide to overlook a higher debt-to-income ratio.

Conventional Loan Requirements

Conventional loans have varying requirements, and most are not as forgiving as the USDA loan option.

These requirements vary depending on whether the loan is conforming or non-conforming.

Conforming Conventional Loan Requirements:

  • Limits on the Loan Amount: The FHFA (Federal Housing Finance Agency) set limits on these loans. The limit set is $548,250 for a single-family residence. Some areas of the country have significantly higher home prices, and the limit on high-value loans is set around $822,375.
  • Credit Score: To qualify for a conforming conventional loan, you must have a 620 or higher credit score.
  • Down Payment: Unlike USDA loans that require zero down payment, a conforming conventional loan requires a down payment. This amount depends on if you are a first-time home buyer (which could be as low as 3% down) or up to 5% down if you are not a first-time buyer. For down payments under 20%, you will be required to pay mortgage insurance premiums, however.
  • Debt-to-Income Ratio: DTI is calculated by taking your gross income (before taxes) and comparing that to your monthly debts, including the proposed mortgage payment. For a conforming loan, your DTI must be 50% or less of your income.

Non-conforming Loan Requirements

These loans do not have guidelines and set requirements in the same way as the conforming loans.

The lender will set their requirements, so it’s important to ask what those are and be certain to understand them.

>> More: Conforming vs. Non-Conforming Loans

What is the Difference Between USDA and Conventional Loans?

These two loans are very different, not just in structure but in requirements. Once you have determined if your property is in a designated rural area that will qualify for a USDA loan, the differences between the loan options are significant.

Down Payments, Credit Score Thresholds, Income Limits

A USDA loan doesn’t require down payments and strict credit score thresholds, but they do have limits on how much income you can earn and how much debt to income you can have to qualify.

On the other hand, conventional loans have credit score thresholds and income limits and require a down payment.

While non-conforming conventional loans are varied and do not carry strict guidelines, it is up to the lender to approve and may or may not be a good fit for the terms the lender sets.

Location

USDA is only offered in certain rural areas, but conventional loans are offered nationwide.

Residency Requirements

For a USDA loan, it is required that your home be your primary household, and you cannot use this loan for an investment property, or a refinance, or a second home.

Conventional loans allow for all of these; you canrefinance a home, purchase a home or multi-family home as an investment property, or even use a conventional loan for a second vacation home.

Income Limits

For a conventional loan, there are no income limits, so high-earning households are eligible. However, a USDA loan puts a limit on household earnings. This is designed to ensure that USDA loans help lower to moderate-income families.

Private Mortgage Insurance or Guarantee Fees

These fees are required for both loans. If your down payment is less than 20% on a conventional loan, you’ll pay private mortgage insurance (PMI) based on your loan-to-value ratio and your credit score.

Usually, this figure is between 0.1% and 1.5% of the unpaid loan amount. If your loan is higher and your credit score lower, your PMI will likely be more.

For USDA loans, you are required to pay a guarantee fee at your closing and monthly. The upfront fee at closing is 1% of the total loan amount.

The annual fee charged is .35% of the unpaid balance. They divide that amount by 12 months, so it is wrapped up in your mortgage payment.

Appraisals

Both loan types require a home appraisal. This ensures the property is being purchased at a fair market value (protecting both you and the lender).

Typically, a USDA loan (or any government-backed home loan) will have stricter guidelines for the appraisal report than a conventional loan.

This means that if you are trying to buy a distressed property to fix up, a conventional loan might be a better option.

Interest Rates

A bonus for the USDA loan is that these are typically offered with very low-interest rates.

Combined with no down payment requirements, this makes a USDA loan even more affordable. Usually, a conventional loan will have a higher interest rate.

Getting Approved

A USDA loan can take longer to get approved, mainly because the loan goes through two underwriting processes.

This can sometimes range from 30-60 days. A conventional loan is usually a faster closing process, at around 30-45 days.

It is important to find a good mortgage lender, do your research, and understand your specific situation regarding your income, credit, and down payment abilities.

Overall, a USDA loan can be much more affordable than a conventional loan for the low- or moderate-income owner if you meet the requirements.

Bottom Line: USDA vs. Conventional Home Loans

As you can see, USDA and Conventional Loans come with different qualifying requirements and serve two different purposes. Before you buy a house, consider your geographical location.

A USDA Loan makes sense if you are in a rural area, such as the Midwest. If you live in a suburb of a large metropolitan city, then a conventional mortgage makes sense. Consider all options and research which loan makes the most sense.

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Cris Kelly
Crystal Kelly

Crystal Kelly is an editor and writer specializing in personal finance. As a renowned journalist, she contributes to multiple leading financial education and real estate publications. She attended the University of Maryland where she majored in English and minored in Art History. Hailing from Shoreacres, TX, Crystal provides content that helps you make simple financial decisions with confidence. Her area of expertise spans mortgages, loans, and credit cards.