Whether a first time or repeat home buyer, many seek mortgages offering low down payments, flexible guidelines, and affordable payments. Often, two very popular options come down to a comparison of USDA vs. FHA loans. Certainly, the most popular choice is the Federal Housing Administration (FHA) loan. The lesser-known USDA Rural Development loan compares very favorably with FHA. If a buyer qualifies for both loans, he/she chooses USDA just about every time.
USDA vs. FHA Loans – Reasons Buyers Choose USDA
As you will see in this article, both home loans are fantastic options for buyers and current homeowners, but USDA is often the preferred option (assuming the borrower qualifies for both programs). Primarily, buyers choose USDA loans for the no down payment requirement. In addition to 100% financing, lower cost is another advantage when compared to FHA.
Both loans charge a funding fee which is financed into the deal. FHA charges a fee that is 1.75% of the loan amount, where USDA charges 1.00%. On a $200,000 loan amount, this saves $1,500 up-front.
Mortgage Insurance Comparison
Furthermore, both loans charge a monthly mortgage insurance premium (USDA’s version is called an annual fee). This monthly charge directly affects the mortgage payment. For the lowest down payment FHA loan, the mortgage insurance percentage is .85% of the loan amount. To calculate The monthly figure, divide by 12. For example, $200,000 * .85% / 12 = $141.67 per month. Although, the USDA mortgage insurance is only .35%. Using the same scenario, $200,000 * .35% / 12 = $58.33. Assuming the interest rates are the same, the USDA payment is lower every time. This is a huge difference, and it results from the cheaper mortgage insurance.
Therefore, if a buyer has the option, it is pretty obvious to choose the no down payment, lower cost, and lower payment home loan. Save the few thousand that would have been spent on an FHA down payment. Use the funds towards paying off debt, complete some minor home improvements or an emergency savings account. Each reason enhances the benefits for choosing a USDA mortgage loan over FHA.
USDA vs. FHA Loan – Reasons Buyers Choose FHA
OK, we have established that if USDA is an option, most will choose it. However, FHA has so many extra tools to help buyers qualify. Plus, there are USDA eligibility restrictions for property and household income. For these reasons, FHA may be the buyer’s choice. Luckily, FHA loans also provide affordable financing with minimal down payment.
Primary FHA Advantages Over USDA Loans
- Lower credit score
- No income limits, area restrictions, or asset limits
- Higher debt to income ratios
- Renovation loan option
- Non-occupying co-borrower allowed
Even though we have established USDA usually works better for cash to close, payment, and cost, notice how FHA advantages deal with qualifying. In cases with higher income borrowers, FHA has no restrictions. Although the USDA income limit is liberal, there is a limit. Another big check in the FHA column is buying in populated areas. USDA is usually not an option within large cities such as Charlotte, Norfolk, Fayetteville, and Charleston. Conversely, FHA has no such restriction.
Credit & Debt Qualification Comparison
When it comes to credit scores, USDA stops at 620. Once under a 640 score, USDA debt to income ratios are also limited to a 41% total debt ratio. FHA has considerable advantages in these areas. First, FHA minimum credit scores are lower. Next, FHA buyers may qualify with higher levels of debt payments. Debt to income ratios may exceed 55%. Finally, buyers with insufficient income may be eligible by adding another borrower. Even more, the additional borrower is not required to live in the property.
Buying and Renovating a Home
Another possible restriction includes properties in need of work. In this case, FHA offers a renovation loan called a 203k. The primary advantage of 203k loans is that they allow buyers to roll home improvements into the loan amount. Therefore, an FHA 203k loan opens up the home buying opportunities. When other loans have issues with property condition, FHA 203k loans solve the problems.
USDA vs. FHA Loans – Similarities
In many areas, USDA and FHA loans mirror each other. These include the same seller paid closing costs up to 6% of the sales price. Both offer 30 year fixed rate terms, yet FHA may offer an adjustable rate as well as shorter-term fixed rates. Also, limited credit and manual underwriting work with both loan types. Even both loan types have similar prior foreclosure and short sale requirements. USDA and FHA treat income based and deferred student loan payments identically. Finally, both loans allow first-time or repeat buyers.
USDA vs. FHA Loan Comparison Chart
|Term Available||30 Year Fixed Only||10 - 30 Years||FHA|
|Adjustable Rate Available||No||Yes||FHA|
|Max Seller Paid Costs||6% of Price||6% of Price||Tie|
|Minimum Down Payment||Zero||3.5% of Price||USDA|
|Max Debt To Income Ratio||45% ish||55% +||FHA|
|Minimum Credit Score||620||580||FHA|
|Income Limits||Household Income Limits||No||FHA|
|Property Eligibility Areas||Yes||No||FHA|
|Income Based Student Loans||1% of Balance||1% of Balance||Tie|
|Second Home or Rental||No||No||Tie|
|Count New Rental Income||No||Yes, If Meets Rules||FHA|
|Have 2 of The Same Loans At Once||1 USDA Loan At A Time||2 FHA Loans - If Meets Rules||FHA|
|Combine with DPA||Allowed||Allowed||Tie|
|Funding Fee Amount||1% of Loan||1.75% of Loan||USDA|
|Monthly Mortgage Insurance||.35% of Balance||.85% of Balance **||USDA|
|Loan Above Price Up To Value||Yes||No||USDA|
|Liquid Asset Restrictions||20% of Sales Price||No||FHA|
|Renovation Loan||Minor Escrow Repair||Yes, 203K Renovation||FHA|
|Gift Funds OK||Yes||Yes||Tie|
|Loan Limits||Conforming Loan Limits||FHA Loan Limits||USDA|
|Appraisal Type||FHA Appraisal||FHA Appraisal||Tie|
|Bankruptcy||3-Year Discharge||In Bankruptcy Possible||FHA|
|Foreclosure||3 Years, Possible Exception||3 Years, Possible Exception||Tie|
|Short Sale||3 Years, Possible Exception||3 years, Possible Exception||Tie|
|New Home Construction||Allowed||Allowed||Tie|
**Assumes mortgage insurance for FHA’s minimum 3.5% down payment 30-year term. FHA Mortgage insurance decreases with higher down payment and/or shorter loan term.
Whether a buyer’s choice is a USDA or FHA loan, both offer incredible flexibility and affordability. Although we have mentioned much of the primary advantages, disadvantages, and even similarities, our comprehensive chart gives a side by side comparison of USDA vs. FHA.
In addition to reading this article, we encourage you to check out our other informative blog posts. Additionally, feel free to reach out to an OVM Financial loan officer for questions, scenarios, or loan pre-approval.