USDA loans and FHA loans might seem to be the same type of loan, after all they are both backed by the government, but upon closer inspection, you will see vast differences. While both loans are made to make it easier for first-time home buyers to get into a home, they can both be used for the subsequent purchase of a home, as long as no other home is owned at the time. That is where the similarities end – both loans target a different demographic. If you qualify for a USDA loan, you might find slightly lower rates and less fees, which could result in a more affordable mortgage.
USDA loans are written strictly for homes in rural areas. According to the USDA, rural means an area that is outside of the city limits and has a population of less than 20,000 people. This means that many areas throughout the United States are considered rural, even if you would not normally consider the area as such. FHA loans can also be used in this area, but will not carry the same benefits as the USDA loan. FHA loans are not restricted by the same boundaries – they rely more on the qualifications for the loan, such as employment, income and even credit score.
The FHA loan is always known as the loan with little down payment requirements; the minimum is 3.5 percent of the loan amount. This is the perfect loan for people that are having a hard time saving enough assets to put down on a home. The USDA loan can make the FHA loan down payment requirement seem high as it requires no down payment in order to qualify for a loan though. There is no minimum and even if you are financing 100% of the loan, you can roll in the closing costs into your loan, increasing the LTV above 100%.
Typically for a loan, such as is the case with the FHA loan, the more income you make, the better off the terms of your loan. A higher income usually means a lower debt-to-income ratio which means that you are a lower risk for the bank. The USDA loan, on the other hand, is strictly for those borrowers that do not have a high income; it targets those with low to middle-of-the-road income. This is done in an effort to build up the rural areas with people that have lower income rather than provide a loan with no down payment requirements to just anyone. If you make more than 115% of the median income for your area (every area differs based on the cost of living) you are not eligible for the USDA loans.
Both the USDA loans and FHA loans want to see a consistent work history. You might find a little more leeway with the USDA loans as long as you are earning an income and are within the same industry, but they will not deny you strictly based on your employment history. The only negative with the USDA loan is if you do not have a 2-year history of employment, you will not be able to factor any bonus or commission income into your income, which could hurt your debt-to-income ratio. On the other hand, it might not matter as the USDA is more forgiving when it comes to higher debt-to-income ratios as long as there are compensating factors.
Both the USDA loans and FHA loans are lenient when it comes to credit scores; or at least more lenient than conventional loans. FHA loans do require a minimum credit score of 580; if the score is less than 580 and above 500, an FHA loan might still be available, but the minimum down payment requirement will be 10%. The USDA loan does not have a minimum credit score and will typically work with any borrower that can show that they can afford the new loan.
Fees for USDA Loans and FHA Loans
Both USDA loans and FHA loans have fees in addition to your standard closing costs and processing fees. The USDA charges a guarantee fee, which is how the USDA is able to help lenders in the face of a default of one of their loans. This fee is charged upfront and annually. The upfront fee is 2.0% of the loan amount and the annual fee is .5% of the loan amount, which is equally divided among your payments per year. The FHA loan charges an upfront fee as well; this amount is 1.75% of the loan amount. The annual Mortgage Insurance Premium for the FHA loan is .85%. As you can see the upfront fees are higher on the USDA loans, but the annual fees are lower for it when compared to the FHA loans.
There are some similarities and many differences between the USDA loans and FHA loans. Both loans are backed by the government, but only the USDA loan is guaranteed – the FHA loan is insured. Both loans offer many benefits to borrowers, making it much easier to get a home loan. If you live in an area where USDA loans are not available, the FHA loan would be the next best alternative.