USDA vs. FHA Loans: What Are The Differences?

Written by Crystal KellyUpdated: 28th Dec 2021
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For low to moderate-income earners, both the USDA and FHA loans are good options that allow for low to no down payment options, loser credit score requirements, and low-interest rates.

Take a look at the differences between the two to see which one is the right loan for you.

USDA vs. FHA Overview

The U.S. Department of Agriculture (USDA) and the Federal Housing Administration (FHA) are two federal government agencies that back these two mortgage options.

Both loans have different eligibility requirements, which includes your income, down payment options, and the location of the home you want to buy.

A USDA loan requires that you purchase in a rural area and is designed to encourage development in these areas.

USDA Eligibility

The USDA offers two loan options for those that will qualify, and each one has different requirements.

  • USDA Guaranteed Loan: Low to moderate-income buyers can opt for this loan from a private lender, but the loan is backed by the USDA. There are no borrowing limits set or property restrictions.
  • USDA Direct Loan: This loan caters to low and very low-income buyers that need extra underwriting to get approval. The USDA will fund the loan, but there are tighter income qualifications and requirements for the property type. The limit a buyer can borrow is $285,000 in most counties.

USDA loans are only available to buyers in rural areas that have low to medium incomes. There are no down payments required, but you do have to meet a minimum credit score of 640 and pay a 1% guarantee fee upfront plus an annual fee that equals .35% of the total loan amount.

The income threshold for a USDA loan is up to 114% of the median household income. Your debt-to-income ratio cannot exceed 29% of your monthly housing costs and up to 41% of monthly debt payments.

There are no loan limits for Guaranteed Loans, but for Direct Loans, the limit is $285,000.

Your property must be a single-family residence in a rural area, and your mortgage will be a 30-year fixed rate term.

FHA Eligibility

For FHA loans, the eligibility requirements differ. These loans are less strict and allow for a lower credit score threshold.

You can also purchase a multi-family dwelling with an FHA loan. There is a 3.5% down payment requirement with a credit score of 580 or up, and if your score is 500-579, you’ll have a 10% down payment requirement.

There are no income limits to qualify for FHA, but the debt-to-income ratio requirement is 31% or less for monthly housing expenses and 43% or less monthly debt payments.

FHA also has a loan limit in most areas of $356,362 for a single-family residence. The terms they offer are a little more varied than USDA; 30 year fixed, 15 year fixed, and adjustable-rate loans are also available.

Mortgage insurance is required, and the upfront cost is 1.75%, and the annual fee for mortgage insurance premium is up to 0.85%.

What Are the Differences Between FHA and USDA Home Loans?

It is important to note, that USDA and FHA Loans are vastly different and serve different purposes. Below are a few key points that highlight the differences.

Down Payment Requirements

USDA loans will finance a qualified buyer 100%. There are no down payments required. FHA loans require at least a 3.5% down payment. This is still less than conventional loans require.

Mortgage Insurance

USDA and FHA loans both require upfront and annual mortgage insurance premiums. The USDAs are a little less expensive.

For the USDA, the upfront mortgage insurance is just 1% on the loan, and the annual is 0.35% of the loan balance.

For FHA loans, the upfront mortgage insurance premium is 1.75%, and the annual is 0.85% of the loan balance. These fees are required for the life of the loan.

>> More: FHA Mortgage Insurance Premium Guide

Appraisal Process

To be approved for either one of these loans, you must go through the home appraisal process. This appraisal lets the lender know that the house you are trying to buy is priced at a fair market value.

For USDA loans, this appraisal process also certifies that the property is located in a rural area, a requirement for USDA loans.

In this case, the home’s property value cannot exceed more than 30% of the home’s value, and there must be access to a street and maintained roads.

FHA loan appraisals also assure the bank that the home is at fair market value, but they also determine that it is up to safe living standards for health and safety.

A home inspection is not required for either one of these loans, but it is encouraged.

Applications and Underwriting Process

Pre-approval is necessary for both loans, as it signifies you are a serious buyer and can be approved for a mortgage.

A preapprovalis a notch better; this allows the mortgage lender to run your credit and check your income and tax documentation to determine the loan amount you can be approved for. This starts the underwriting process.

Getting a USDA loan takes a bit longer than an FHA, mainly because USDA loans go through underwriting twice, first by the lender than by the USDA.

To get your loan application to go through underwriting automatically, you’ll need a credit score of 640 or more.

If your credit score is under 640, you will need manual underwriting, which adds significant time to your loan process. You can expect a USDA loan to close between 30-45 days.

An FHA loan requires 1 to 5 business days for the application and origination part of the loan process.

The next underwriting step depends on how quickly you can submit the required documentation, such as income and taxes.

The mortgage broker you choose will move and close faster if they are an FHA-approved lender. FHA loans can expect to close in 30-45 days, as well.

Interest Rates

Both the USDA and FHA loans offer lower interest rates because both loans are backed by government agencies.

These interest rates are usually lower than or comparable to conventional loan rates. It’s important to note that, even with a lower interest rate, USDA and FHA loans could be more expensive in the long run because of the mortgage insurance requirements.

>> More: Explore All Government Home Loan Options

FHA Pros and Cons

Pros:

  • FHA loans are more forgiving with underwriting requirements
  • Low credit score requirements, as low as 580 in some cases, with 3.5% down
  • Lower credit scores of 500 to 579 can still get a loan but with 10% down
  • Credit history is flexible: not having credit isn’t a reason to deny the loan
  • Flexible debt-to-income ratios, as high as 45%
  • Multi-family units can qualify, up to four units, if one of those units is your primary home

Cons:

  • Higher mortgage insurance premiums, although the upfront MIP can be rolled into the loan amount
  • MIP lasts for the life of the loan unless you put 10% down, then it’s 11 years
  • Owner-occupied homes only
  • Loan limits: maximum loan amounts are $356,362 in 2021 for most areas.

USDA Pros and Cons

Pros:

  • No down payment required
  • No prepayment penalty
  • You can wrap your closing costs into the loan
  • Flexible credit score requirements
  • Lower interest rate options

Cons:

  • The home must be located in a rural area
  • There are income limits: your household limit cannot exceed 115% of your area median household income
  • Single-family homes only
  • You need at least a 640-credit score to qualify
  • Mortgage insurance is required whether or not you make a qualifying down payment

Is a USDA loan or FHA loan better?

Both loans offer benefits to lower and moderate-income households with lower credit scores. If you are looking for a property in a rural area and qualify for a USDA loan, you can save significantly by having zero down payment and lower mortgage insurance premiums.

An FHA loan is a good fit for those lower-income home buyers who need the flexibility of loose credit requirements, a low-down-payment option, and higher thresholds for debt-to-income ratios.

FHA loans can end up costing more over the life of a loan because of higher mortgage insurance premiums.

Bottom Line: USDA vs. FHA Home Loans

As you can see, USDA and FHA Home Loans are both backed by the U.S. Government; however, their “use” cases and requirements are different.

Before you buy a house, consider your geographical location and needs. This will help you decide which loan option is best.

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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.