USDA vs. FHA Loans

USDA and FHA loans are mortgages that help low-to-moderate-income individuals purchase a home. These mortgage options are usually more accessible to borrowers with limited income, because they have lower credit score and down payment requirements than conventional home loans.

Both USDA and FHA loans are guaranteed by a government entity and have fixed interest rates. However, they are two distinct mortgages with their own qualification criteria. In this article, we’ll discuss the difference between FHA and USDA loans, the pros and cons of each loan, and how to decide between the two types of mortgages.

What is a FHA loan?

An FHA loan is a mortgage offered by a private lender and guaranteed by the Federal Housing Administration (FHA). If a FHA borrower is unable to continue making monthly payments, the Administration will provide the lender with insurance to cover the losses. 

Similar to USDA loans, FHA loans are both insured by the federal government and offer 30-year terms with fixed, or adjustable interest rates. You might qualify for a FHA loan if you’re a first-time homebuyer or haven’t owned a home in the last three years. Here’s a closer look at the pros and cons of a FHA loan.

Pros

Flexible credit requirements: Most FHA lenders accept credit scores as low as 580, while some accept credit scores as low as 500 with a 10% down payment. FHA lenders are also flexible with credit history. Borrowers can't be denied solely due to a lack of credit history.

Flexible debt-to-income ratios (DTI): FHA lenders might approve home loans for borrowers with DTI ratios of up to 55%, which is usually the same requirement for most USDA lenders. 

Cons

Higher mortgage insurance costs: FHA home loans come with an upfront mortgage insurance premium (UFMIP) of 1.75% and an ongoing mortgage insurance premium (MIP) between 0.15% and 0.75%, depending on the lender. 

Loan limits: FHA borrowers are limited in terms of how much they can borrow. The FHA  sets loan limits based on the median home price in a specific area. If you want to use a FHA loan to purchase a home outside of your corresponding loan limits, you might have to pay for the difference in cash or look for a less expensive property.

What is a USDA loan?

A USDA rural development loan is a mortgage offered or insured by the U.S. Department of Agriculture. If a USDA borrower is unable to continue making monthly payments, the USDA will cover the cost of the loan. The main difference between a FHA home loan and a USDA home loan is that USDA loans are reserved for properties located in a designated rural area.

Pros

No down payment: USDA loans allow borrowers to finance up to 100% of a home’s property value with 0% down. In some cases, the home’s property value is above the home’s purchase price, allowing homebuyers to finance closing costs and other upfront expenses. Depending on your loan amount, you might be able to buy a home with almost nothing out of pocket.

No prepayment penalty: Many lenders charge borrowers a fee for paying off their mortgages early. If you get a USDA loan on a 33- or 38-year term, but decide to pay it off a few years early, you won’t be penalized for it. 

Cons

Location restrictions: USDA loans are only available for homes located in rural and suburban areas determined by the USDA. Properties located in urban areas automatically do not qualify. Borrowers might find living in a rural or suburban area challenging if they don’t have access to reliable transportation, or work in a city center.

Income limits: USDA loans are available for borrowers who make less than 115% of the median income level in their county. In most counties, if you make more than $112,450 and live with 1-4 members in your household, you won’t qualify for a USDA loan. Homes with 5-8 members are capped at $148,450. 

Difference between FHA and USDA loans

Although USDA and FHA loans attract similar types of borrowers, they’re two different home loans. Consider how loan requirements, loan limits, and other criteria apply to USDA vs. FHA loans. 

How to decide between a USDA or FHA loan

Deciding between a USDA loan and a FHA loan can be difficult if you qualify for both. Consider the following questions if you’re undecided.

Does your income fall within USDA limits?

USDA loans have income limits organized by county and income level, while FHA loans do not have income limits. If you fall outside of USDA limits in your area, you won’t qualify for a USDA loan. You can get approved for an FHA loan regardless of how much money you make. Check if you pre-qualify for an FHA loan with us at Zillow Home Loans*. The process takes as little as five minutes and has no impact on your credit.

Are you buying a single- or multi-family home?

Multi-family homes don’t qualify for USDA loans, even if that home would be your primary residence. USDA loans can only be used for single-family homes. If you want to buy a multi-family home, you’ll have to get a FHA loan. 

Are you buying in a rural, suburban, or urban area?

Property location will also influence the type of loan you can get. USDA loans are only available for homes located in certain rural and suburban areas throughout the country. Although most states have a USDA-designated area, it might not be located in an area you’d like to live. FHA loans don’t have any location restrictions. 

Do you have enough saved for a down payment?

Deciding between a USDA loan and a FHA loan might come down to whether you can afford a down payment. Some USDA lenders offer 100% financing to eligible borrowers. FHA loans require a minimum 3.5% down payment. If you’re purchasing a home for $350,000 with a FHA loan, you’d need a down payment of at least $12,250. If your credit score is below 580, your down payment could more than double to 10%, or $35,000. Consider your creditworthiness and ability to afford a down payment. 

Do you prefer a shorter or longer term loan?

Borrowers should consider how much time they need to repay a home loan. If you prefer a faster payoff period and can afford higher monthly payments, a 15- or 30-year FHA loan might be best. However, if you prefer a longer payoff period and can’t afford higher monthly payments, USDA loans offer 33- and 38-year terms.

*Zillow Home Loans; an equal housing lender. NMLS #10287.