FHA vs USDA: Which One Is Better?

Home buyers on modest incomes often favor mortgages with flexible borrowing conditions, particularly regarding down payments and mortgage insurance. This is why USDA and FHA loans hold significant appeal for borrowers.

But what sets these two mortgage options apart? This article will walk you through the contrasting eligibility criteria and processes of each loan.

The Battle Between USDA and FHA Home Loans

USDA and FHA loans, backed by the U.S. Department of Agriculture and the Federal Housing Administration, offer government support. These loans don’t directly lend money but shield your lender from losses in case of default.

Unlike conforming loans, USDA and FHA loans aren’t bound by housing standards of Fannie Mae and Freddie Mac. Nevertheless, government-backed loans have specific eligibility requirements, like other loan types.

Contrasts Between FHA and USDA Loans

USDA and FHA loans are overseen by distinct government agencies, leading to varying criteria for application, underwriting, appraisal, loan amounts, mortgage insurance, and interest rates.

Application Process And Underwriting

To embark on the path to homeownership, securing preapproval is crucial regardless of the mortgage product you opt for, be it USDA or FHA loans. Preapproval signals your commitment to buying a home, instilling confidence in sellers regarding your mortgage eligibility.

Alternatively, you may consider a prequalification, where the lender assesses your information for an initial decision. With preapproval, the lender delves deeper, analyzing your credit history and requesting documents like tax forms and pay stubs to accurately determine your home purchasing capacity.

Obtaining a USDA or FHA preapproval/prequalification initiates the mortgage underwriting process, enabling you to house hunt without the worry of potential approval issues.

Closing Process With A USDA Loan

Securing a USDA loan typically involves a lengthier process compared to an FHA loan. This is mainly because USDA loans undergo a dual underwriting process – first by the lender and subsequently by the USDA. A credit score of 640 or higher is required to qualify for automatic USDA underwriting.

For individuals with credit scores below 640, manual underwriting is necessary, leading to a longer loan approval timeline. The duration of the underwriting process varies based on the location of the property being purchased and the backlog at the local USDA agency. On average, anticipate a USDA loan to be finalized within 30 to 45 days.

Closing Process With An FHA Loan

An FHA loan typically closes within 30 to 45 days, subject to the application process and underwriting duration. The initial stages of application and preapproval usually span 1 to 5 business days. Timely submission of required documentation like employment status, income details, tax returns, and bank statements significantly impacts processing speed. The involvement of multiple parties can influence the timeline; for instance, collaborating with a mortgage broker lacking FHA approval might necessitate engaging another party, potentially causing delays in the transaction process.

Maximum Loan Limits

FHA loans come with set loan limits, meaning you’re restricted from purchasing a property that surpasses the amounts defined by the Department of Housing and Urban Development (HUD). For lower-cost areas in 2023, the maximum FHA lending amount stands at $472,030, while it scales up to $1,089,300 for high-cost regions.

In contrast to FHA loans, USDA loans do not have defined loan limits in a technical sense. Instead, the maximum sum is determined based on your capacity to repay.

The Appraisal

The appraisal stands as a pivotal element in the mortgage approval journey, whether opting for a USDA or FHA loan. This evaluation provides the lender with assurance that the property is being transacted at a just market value. A mandatory step for both loan types, it plays a crucial role in safeguarding both your interests and those of the lender.

USDA Appraisals

To ascertain the accurate valuation of a home for a USDA loan, the appraiser must verify the property’s location within a USDA-designated rural area and its habitability. The land’s worth should not exceed 30% of the property’s value, with necessary access to streets and well-kept roads.

FHA Appraisals

An FHA appraisal involves more than just assessing value; it necessitates meeting specific requirements. The appraiser must ascertain the property’s current market value and ensure it complies with FHA health and safety standards. While neither loan mandates an independent home inspection, it’s advisable to conduct one to identify potential issues. Any significant problems detected by an inspector must be addressed before the loan can be finalized.

Down Payment Requirements

USDA loans and FHA loans differ significantly in their down payment requirements. An FHA loan mandates a down payment of 3.5% for a credit score of 580 or above, while a score between 500 – 579 necessitates a 10% down payment.

Conversely, USDA loans eliminate the need for any down payment, making it one of the most attractive features of this loan option.

Mortgage Insurance

The USDA and FHA depend on mortgage insurance to fuel the growth of their loan programs. This insurance steps in to repay your lender in case you default on your loan, a requirement even if you make a 20% down payment.

Mortgage Insurance Premiums

FHA loans necessitate a mortgage insurance premium (MIP) payment for the entire mortgage term unless a down payment of 10% or more is made, in which case MIP ceases after 11 years. 

Typically ranging from 0.15% to 0.75% of the base loan amount, this fee is contingent on the mortgage term and loan-to-value ratio (LTV), calculated as the borrowed amount divided by the home’s value. 

The total mortgage sum and down payment size also influence this assessment. Additionally, an upfront mortgage premium of around 1.75% of the base loan amount is required for FHA loans.

Guarantee Fee

To secure a USDA loan, you’ll need to cover a guarantee or funding fee, payable in two ways: upfront at closing and monthly throughout the loan’s term. The initial fee amounts to 1% of the total loan, while the ongoing premium, equivalent to 0.35% of the outstanding principal balance, is included in your regular monthly payment.

Interest Rate

USDA and FHA loans generally feature lower interest rates due to government backing, providing increased flexibility with reduced rates. Typically, these loans offer interest rates on par with or lower than those of conventional loans. Nonetheless, the mandatory mortgage insurance may lead to higher overall costs throughout the loan term.

Closing Costs

For both types of home loans, the buyer may still need to cover the closing costs. USDA loans offer the flexibility to finance up to 100% of a home’s appraised value, which may exceed the purchase price. Any surplus can then be allocated towards the closing expenses. Alternatively, you have the option to discuss seller concessions, which could potentially cover up to 6% of your closing costs for either loan.

USDA versus FHA Loans: Understanding Eligibility Criteria

USDA and FHA loans have distinct mortgage eligibility criteria. Key factors determining eligibility encompass home location, income level, credit score, debt-to-income (DTI) ratio, and down payment size. Let’s delve into each of these qualifications.

Requirements for USDA Loan Eligibility

USDA loans, referred to as rural development loans, aim to boost homeownership and rural economies nationwide. To qualify for a USDA loan, you must commit to buying a home in an eligible rural area meeting specific guidelines and state property criteria. Here are a few key points about USDA loans:

• Income: The USDA imposes stringent income criteria, varying by your home’s location and household size. If your household income surpasses 115% of the median for your area, you are not eligible for a USDA loan. Choose your state to view income thresholds for the county where you intend to buy your home.
• Credit Score: While there is technically no set minimum credit score for a USDA loan, numerous lenders may expect a score of at least 640. Your credit score, a three-digit number, reflects your consistency in repaying debts.
• Debt-to-Income Ratio: Your DTI, representing your expenses compared to your income, should ideally remain at 41% or below for financial stability.
• Down payment is unnecessary for USDA loans as they are zero-down loans, eliminating the need for any upfront payment.

FHA Loan Eligibility 

FHA loans cater to low- to moderate-income Americans. Eligibility for an FHA loan can be determined through an FHA-approved lender, particularly if you are a first-time homebuyer or haven’t owned a home in the last 3 years. Here are some additional key points about FHA loans:

• For those with a credit score of 580 or above, a 3.5% down payment is necessary. If your credit score falls in the 500 – 579 range, a 10% down payment is required to secure an FHA loan. 
• Income requirements are not mandatory for FHA loans, but verifying your income is crucial to demonstrate your ability to cover mortgage and insurance payments each month.
• When it comes to the debt-to-income ratio, even with a higher DTI relative to your income, you could still qualify for an FHA loan, especially if your credit score is strong.

The Bottom Line

USDA and FHA loans aim to assist individuals in lower income brackets to buy a home. However, the eligibility criteria may influence your choice between the two. 

Considering an FHA loan? Discover the rates you qualify for by applying online with Elevation Mortgage.