USDA loans and FHA loans have a few things in common – they are both backed by a government agency and they both have lenient guidelines when it comes to qualifying for them. Where they differ, however, is in the amount of mortgage insurance you have to pay for in order to have the loan. Both loans require an upfront fee which you can pay at the closing or wrap into your loan amount as well as annual mortgage insurance, which you pay monthly in your regular payments, but the amounts differ.
FHA Mortgage Insurance
FHA loans are backed by the FHA. They have flexible qualifying guidelines and do not require very high credit scores. Because of that, the agency requires upfront mortgage insurance to fund the reserve account that they hold in order to make good on the claims that lenders have to make in order to get paid on the loans that their borrowers default on. The reserves are funded with the 1.75% of the loan amount that each borrower pays. On a $200,000 loan, you would pay $3,500 at the closing or wrap it into your loan amount if you are eligible to do so.
The FHA also charges annual mortgage insurance to further the reserve funds of their account. This money, however, gets paid monthly and is equal to 0.85% of the outstanding loan amount. On the $200,000 loan, this amount would equal $141.67 per month, but would change each year as the amount of the outstanding principal decreases.
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USDA Mortgage Insurance
USDA loans are backed by the USDA and have similarly flexible guidelines. These loans were created for low and very low income families in an effort to help them become homeowners. This program also requires upfront and annual mortgage insurance. The upfront mortgage insurance funds the USDA’s reserve account, much the same as the FHA’s upfront mortgage insurance does. The amount you pay on a USDA loan is 2.75% of the original loan amount. Typically, most borrowers roll this cost into their loan, which the USDA automatically does for you in an effort to make the loan more affordable. On a $150,000 loan, the amount that would be required upfront equals $2,625.
The USDA charges mortgage insurance on an annual basis as well. This money helps to fund the reserve account and is equal to 0.5% of the outstanding loan amount. In the start of a $150,000 loan, the amount would equal $62.50 per month, but would change yearly as the amount of the outstanding principal decreased.
What’s the Difference?
Let’s take a look at a $125,000 loan for both the USDA and the FHA loans to see which would cost you less in the end:
- FHA Loan – The mortgage insurance on this loan would equal $2,187.50 (the upfront mortgage insurance) plus $88.54 per month for annual mortgage insurance. For the first year, the total amount you would pay would be $3,249.50.
- USDA Loan – The mortgage insurance on this loan would equal $3,437.50 (upfront mortgage insurance) plus $52.08 per month for annual mortgage insurance. For the first year, the total amount you would pay would be $$4,062.50.
The loan you qualify for should dictate which program you use. As you can see, the FHA loan is the more affordable option as far as mortgage insurance; however, not everyone will qualify for this program. If you are a low or very low income family, qualifying even for an FHA loan might prove to be a hardship, which is why the USDA loan is a great option for these families. If you purchase a home in a rural area, you are eligible for this program. Shop around with various lenders to see how much you can get your closing costs down and then enjoy the benefits of either of these government-backed loans.