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When it comes to financing a home purchase, there are various mortgage options available to homebuyers, each with its own unique features, requirements and advantages.
When deciding if a USDA loan is right for you, it’s helpful to compare these loans to other loan types, such as FHA, VA and conventional loans, to help you determine which option best suits your needs and goals.
USDA Loans: The Basics
Before diving into comparing USDA loans to other loan options, let's briefly understand the basics of USDA loans:
- Eligibility requirements: The property must be located in a designated rural area and the buyer must be a U.S. citizen or permanent resident.
- Down payment: No down payment is required, making USDA loans an attractive option for those with limited funds for upfront costs.
- Minimum credit score: The USDA does not set a minimum credit score requirement, but lenders typically look for a 640 credit score.
- Maximum income limit: Total household income cannot exceed local USDA income limits, or 115% of your area’s median household income.
- Maximum loan limit: The USDA does not have a set loan maximum limit, limit depends on the borrower’s qualifications and financial situation.
- Minimum property requirements: The property must meet specific minimum property requirements, be the borrower’s primary residence and a single-family home.
- Mortgage insurance: Private mortgage insurance (PMI) is not required, but borrowers will pay an upfront guarantee fee of 1% at closing and an annual fee of 0.35% that will be lumped into the monthly payment throughout the life of the loan.
- Closing costs and fees: Closing costs generally range from 3% to 6% of the total loan amount, and seller concessions are capped at a maximum of 6%.
USDA Loans vs. FHA, VA and Conventional Loans
| USDA | FHA | VA | Conventional | |
|---|---|---|---|---|
| Eligibility Requirements | Designated rural area | Consistent employment for two years | Military Veteran, active service member, member of National Guard or Reserves or surviving spouses | Determined by borrower’s financial situation |
| Minimum Down Payment | None | Generally 3.5% of loan amount | None | Typically 5-20% of loan amount |
| Minimum Credit Score | None | 580 | None | 620 |
| Maximum Income Limit | 115% of area’s median household income | None | None | None, with the exception of HomeReady and Home Possible loans |
| Maximum Loan Limit | None | $524,225 - $1,209,750 | None for Veterans with full entitlement | $806,500 - $1,209,750 |
| Minimum Property Requirements and Occupancy | Must serve as primary residence, be a single-family home and adhere to USDA MPRs | Must serve as primary residence and adhere to FHA MPRs | Must serve as primary residence, adhere to VA MPRs and buyer must move in within 60 days of closing | Can be used for any type of residence, including investment properties and second homes |
| Mortgage Insurance | No PMI required | Required | No PMI required | Required if down payment is less than 20% |
| Closing Costs and Fees | Typically 2-6% of total loan amount and up to 6% seller concessions | Typically 2-5% of total loan amount and up to 6% seller concessions | Typically 3-6% of total loan amount and up to 4% seller concessions | Typically 3-6% of total loan amount and up to 9% seller concessions with at least 25% down payment |
Note: At Neighbors Bank, we typically look for a minimum FICO credit score of 620. For borrowers who don't meet our credit requirements, we offer a free credit consulting.
USDA Loans vs. FHA Loans
FHA loans, which are insured by the Federal Housing Administration, are often a popular loan option, especially for first-time homebuyers. Let's explore how USDA loans compare to FHA loans:
Advantages of FHA Loans vs. USDA Loans
FHA loans present several advantages over USDA loans, including:
- FHA eligibility requirements do not have restrictions on where the property is located, offering more flexibility for homebuyers in non-rural areas.
- While FHA loans do require a minimum credit score of 580 with a 3.5% down payment, this requirement is less than the benchmark minimum credit score of 640 that many USDA lenders look for.
- Unlike USDA loans, FHA loans do not have a maximum income limit. These loans may be a more suitable option for high-income borrowers.
Disadvantages of FHA Loans vs. USDA Loans
However, FHA loans also have their drawbacks when compared to USDA loans:
- FHA loans require a minimum down payment of 3.5%, which can be a significant upfront cost for some borrowers.
- With a 3.5% down payment, FHA loans require a minimum credit score of 580. Borrowers falling below this credit requirement will likely need to increase their down payment to qualify for an FHA loan.
- FHA loans have a maximum loan limit that varies by county, which may limit borrowing capacity in high-cost areas. This loan limit starts at $524,225 but can reach $1,209,750, depending on the location of the property.
- FHA loans require a mortgage insurance premium (MIP) both up-front and on an annual basis throughout the life of the loan.
Ultimately, the choice between USDA loans and FHA loans will depend on individual circumstances, such as the desired property location, credit score and financial capacity of the potential borrower. Whether it's the convenience of FHA loans or the benefits of USDA loans, finding the right fit will set the foundation for a successful and rewarding homeownership journey.
USDA Loans vs. VA Loans
VA loans can be a great option for qualifying Veterans. These loans are backed by the U.S. Department of Veterans Affairs and are known for their relaxed financial requirements when compared to other mortgage types. Here’s how they compare to USDA loans in particular:
Advantages of VA Loans vs. USDA Loans
VA loans offer some distinct advantages over USDA loans, particularly for eligible Veterans and active-duty service members:
- While VA loans have their own unique eligibility requirements to consider, they are not restricted to only rural areas.
- VA loans have no maximum income limit, providing more flexibility for higher-income borrowers.
- VA loans can be used for a wider range of property types in addition to the single-family homes that qualify for USDA loans. This offers more potential property options for VA homebuyers.
Disadvantages of VA Loans vs. USDA Loans
Along with their advantages, VA loans also have some disadvantages compared to USDA loans:
- To qualify for a VA loan, borrowers must be eligible Veterans or active-duty service members.
- While VA loan limits no longer apply to those with their full VA loan entitlement, there are still limits in place for those with reduced entitlement. In these cases, VA loans are typically capped at $806,500, but this limit may increase up to $1,209,750, depending on the location of the property.
- Though VA loans have a similar range of total closing costs when compared to USDA loans, this loan type has a maximum seller concessions limit of 4%.
The choice between USDA loans and VA loans will depend on your personal situation and eligibility criteria. Veterans and active-duty service members can benefit greatly from the advantages offered by VA loans, while USDA loans provide an excellent option for those seeking affordable homeownership in eligible rural locations.
USDA Loans vs. Conventional Loans
Conventional loans are generally the most popular loan type for their flexibility. These loans are not backed by any government agency and are offered by private lenders. Here's how USDA loans differ from conventional loans:
Advantages of Conventional Loans vs. USDA Loans
Conventional loans offer several advantages over USDA loans, making them a preferred choice for some borrowers:
- Qualifying for a conventional loan depends primarily on the borrower’s financial situation, rather than set eligibility criteria like that of USDA loans.
- There are no restrictions on the type or location of the property for conventional loans. Borrowers are not limited to purchasing a single-family home that serves as their primary residence when using a conventional loan over a USDA loan.
- While conventional loans have a set minimum credit score of 620, this minimum falls below the benchmark credit score of 640 that many USDA lenders look for.
- For most conventional loans, there is no maximum income limit for potential borrowers.
- However, keep in mind that HomeReady and Home Possible conventional loans are restricted to borrowers making less than or equal to 80% of their local area median income.
- Conventional loans offer the highest maximum seller concessions of 9%. However, keep in mind that borrowers must put at least 25% down to qualify for this maximum limit.
- With a down payment between 10 and 25%, borrowers qualify for up to 6% maximum seller concessions, while those borrowers with a down payment of less than 10% can negotiate up to 3% for seller concessions.
Disadvantages of Conventional Loans vs. USDA Loans
Like the previous loan types, conventional loans also come with their own set of drawbacks compared to USDA loans:
- Conventional loans require a down payment, typically ranging from 5 to 20% of the total loan amount.
- The financial qualification standards for conventional loans are generally stricter compared to USDA loans.
- Conventional loans have a maximum loan limit ranging from $806,500 to $1,209,750 depending on the property’s location. These limits may impact borrowers looking to purchase properties in high-cost areas.
- Conventional loans require private mortgage insurance (PMI), though this can be canceled once the loan-to-value ratio reaches 80%.
Ultimately, the comparison between USDA loans and conventional loans reveals distinct advantages and disadvantages for potential homebuyers to consider. While conventional loans may stand out for their flexibility, USDA loans offer an appealing option for those seeking affordable homeownership in designated rural areas. Prospective homebuyers should thoroughly evaluate their specific needs and work with knowledgeable mortgage professionals to make the best decision that aligns with their long-term homeownership goals.
Is a USDA loan right for me?
Ultimately, the choice between USDA loans and other loan types depends on individual circumstances, including the property's location and the borrower’s credit score and overall financial capacity. Prospective homebuyers should carefully evaluate their unique needs and situation to make the best decision that aligns with their long-term homeownership goals.
If you weigh the pros and cons of a USDA loan over your other mortgage options and decide this is the right choice for you, reach out to a Neighbors Bank home loan specialist to begin your USDA homebuying journey!
