If you’re buying a home there are few mortgage programs better than FHA and USDA loans.
But how do you know which loan is the best for you?
If you meet all the requirements for a USDA loan then it is the cheaper mortgage.
In this article we will take an in-depth look into the differences between FHA and USDA home loans.
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How to Know if a USDA or FHA loan is Better for You?
Which type of mortgage loan is best for you will depend on your situation. FHA home loans are a good option if you have credit issues because of their low credit score requirements. But the FHA mortgage insurance rate is .5% higher than USDA.
USDA loans are popular because of their low mortgage insurance premium and they do not require a down payment. But they are only available to low income borrowers in rural areas and are harder to qualify for.
When you should get a USDA loan
If you’re home is in a USDA location, have at least a 640 credit score and your household income does not exceed the USDA income limit then you should get a USDA loan.
When you should get an FHA loan
If you’re in an eligible USDA location but either your income surpasses the income limit or have a credit score below 640 then an FHA loan is going to be best for you.
USDA Home Loans
The U.S. Department of Agriculture created the USDA housing program to help farmers and low income families in rural parts of the country become homeowners.
In order to be eligible for a rural development loan you must buy a property located in an eligible rural location.
Fortunately, the USDA map has not been updated in several years so 97% of the country is eligible.
If you live 50 miles away or further from any major metropolitan city your home may qualify.
One of the greatest benefits of USDA loans is that they do not require a down payment. You’re able to finance 100% of the purchase price of the home.
USDA loans like all mortgages will have closing costs and other fees associated with it. You can expect to pay between 2%-5% of the purchase price in closing costs.
USDA does allow for the seller to pay up to 6% of these costs. If you cannot afford to pay upfront for the costs you should consult your real estate agent about asking the seller to contribute to your closing costs.
Mortgage insurance is required with USDA mortgages, but they have the lowest rates. While an fha loan has a mortgage insurance premium of 0.85% of the loan amount. USDA loans have a much lower mip rate of 0.35%.
USDA Loan Benefits
- No down payment
- Low mortgage insurance premium
- Competitive mortgage rates
- High debt-to-income ratios accepted
- Great for low income households
USDA Loan Requirements
- 640 credit score minimum
- Property located in USDA eligible location
- Income limit of 115% of the area median income
- 2 years of steady employment
- No mortgage late payments in last 30 days
Before the Federal Housing administration was created you needed a large down payment and excellent credit to qualify for a mortgage.
FHA loans were created to encourage homeownership after the Great Depression.
Today FHA loans are the most used type of mortgage for first-time home buyers. Their low down payment and credit score requirements make them an attractive option for borrowers without a lot of money to put down.
The FHA does not issue mortgage loans, they insure the loan. In the event a borrower defaults on the mortgage the FHA pays the lender the remaining balance on the loan and takes ownership of the house.
Credit Score Requirements
Borrowers with a credit score of 500-579 may qualify for an fha mortgage with a 10% down payment.
Borrowers with at least a 580 credit score are required to have a 3.5% down payment.
However, lenders set their own borrower requirements making getting an fha loan with a credit score below 580 nearly impossible.
If you have below a 580 credit score it’s highly recommended you take the time to improve your credit before starting a loan application.
Mortgage Insurance Premiums
An FHA loan will require a mortgage insurance premium regardless of your down payment. The FHA mip rate will depend on the amount you put down and the amount of the loan.
Upfront FHA MIP
FHA also has an upfront mip fee of 1.75% of the loan amount that is included in the closing costs. This fee must be paid by the borrower at closing and cannot be rolled into the mortgage loan.
FHA Loan Benefits
- Low interest rates
- Fixed rate and adjustable rate mortgage terms
- 15 year and 30 year fixed-rate mortgage terms
- Low credit score requirements
- 3.5% down payment
- Easier to qualify for than conventional loans
FHA Loan Requirements
- 10% down payment with 500-579 credit score
- 3.5% down payment with 580+ credit score
- Home appraisal done by FHA appraiser
- Prior two years of tax returns and w2’s
- No mortgage late payments in past 12 months
- Must wait 2 years after bankruptcy or foreclosure is dismissed
- Only for owner-occupied borrowers
If you meet all of the requirements for a USDA loan it is a better option than FHA because they do not require a down payment and have a lower mortgage insurance rate. However, they are more difficult to qualify for than FHA loans.
You’ll need to have at least a 640 credit score and your household income cannot exceed 115% of the medical income in your area. If you do not meet all of the USDA requirements, FHA loans are a great option. You really can’t go wrong.
Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.