USDA vs. FHA loan: What’s the difference?
Comparing FHA and USDA loans
- The FHA and USDA loan-guarantee programs provide government support for home mortgages.
- The USDA is more restrictive in that it is only open to properties located in specific geographic areas.
- The FHA requires a minimum 3.5 percent down payment.
- Borrowers using the USDA program can finance the entire amount of the loan.
Government loan programs have historically been popular with first-time homebuyers. Federal Housing Administration (FHA) loans tend to be the most popular government loan option, but U.S. Department of Agriculture (USDA) loans — sometimes referred to a Rural Development (RD) loans — also can be a good option.
The FHA and USDA home mortgage programs are similar in a number of ways, but different in others. The USDA, FHA and most other government loan programs are alike in that, with few exceptions, the government agency does not lend money directly, but rather guarantees loans made by a private-sector lender.
The USDA and FHA work with a group of approved lenders that process the applications and ensure that borrowers qualify. Essentially, the government is guaranteeing that the lenders and the end investors in the loans will not assume all the losses if borrowers default. This reassures lenders, and enables them to lend to a much wider pool of borrowers at competitive rates.
USDA and FHA eligibility guidelines
The USDA and FHA differ in a number of ways. The USDA is by far the smallest government loan-guarantee program, but that’s not because the program is a bad deal for borrowers. The USDA is more restrictive, however, in its lending requirements. Unlike the FHA program, which is open to all borrowers in all areas of the country, you can only qualify for a USDA loan if you live in an area deemed eligible by the USDA.
Typically, USDA-eligible properties are located in rural areas. It is a mistake, however, to think that you have to live far out in the country to qualify for a USDA loan. USDA-eligible properties are often located near urban areas.
A property’s eligibility is determined by its location with respect to USDA’s map of eligible locations. The USDA program also places limits on your household income based on median earnings in an area. If you exceed that limit, you can’t obtain a USDA loan.
The FHA, by contrast, does not place limits on household earnings. The FHA, however, does establish a maximum limit on the amount of money that can be borrowed through the program.
USDA and FHA loan terms
Government loan programs are not designed for affluent borrowers seeking to purchase or refinance a home at the top of the market. The programs are intended to improve access to credit for borrowers in the low- to middle-income brackets.
USDA loans can have certain advantages over FHA loans. One is that the program will finance 100 percent of the property purchase. That means you will not have to put any money down on the home, which is widely viewed as the biggest barrier to homeownership.
The FHA, by contrast, requires a minimum 3.5 percent down payment. The USDA loan-guarantee program is one of only two government loan programs that offers 100 percent financing. The other no-down payment government loan is offered by the U.S. Department of Veterans Affairs (a VA loan), which requires its borrowers to have completed various levels of military service to become eligible.
Another difference is that the FHA and USDA charge different amounts for mandated mortgage insurance. In each case, the borrower has to pay an upfront insurance fee, and an annual insurance fee. It is a good idea to ask your loan officer to compare the costs of both programs.
It is important to evaluate not only how much money you’ll have to pay each month in a mortgage payment, but the total costs over the life of the loan. This includes the interest rate, insurance costs and the various fees.