FHA vs USDA Loans: Explained

by Courtney Christensen

When it comes to picking out the right loan type for you and your family, things can get quite complicated. Between the housing industry terminology, the legalese used in so many of the documents, and the large variety of loan types available – well, it’s no wonder you’re looking for a simpler answer to your question: What’s the difference between and FHA and a USDA loan?

Similarities

Government Backed

Both of these loans were created by the government, who also helps to fund them. Government-backed loans are often pickier when it comes to the house you choose (particularly on the value and condition of home), but they are much more flexible when it comes to the borrower’s eligibility. For instance, both FHA and USDA loans have a lower credit score and income limit than conventional loans.

Appraisals and Inspections

Occasionally, you can purchase a home without an appraisal. This is typically done with a conventional loan or refinance and usually on newer homes. With an FHA or USDA loan, however, an appraisal is likely required. Appraisals judge the value of a home through an unbiased third party, which benefits you, as the buyer. You won’t over-pay for a home when you have a USDA or FHA loan.

Inspections, too, can be bypassed on most loans. However, with an FHA or USDA loan, an inspection is recommended. These inspections (just like appraisals) look at the condition of the home to make sure it meets specific requirements set by the government for both USDA and FHA loans. Inspections tend to go deeper, however, and look at more of the home. They don’t decide the value of a home, but they do inform you of any issues with the home you may have missed – such as the age and condition of the roof and the stability of the foundation. Inspectors can often tell you how much each of these issues will cost to fix which can influence your decision to buy the home.

Mortgage Insurance

If you purchase a home with a conventional loan, you do not have to pay mortgage insurance if you put down a large enough down payment. With a USDA or FHA loan, though, you will need to pay mortgage insurance. Because of their lower down payment costs, mortgage insurance is required to protect the lender in case you default on your loan.

Likely, you will need to pay mortgage insurance throughout the life of your loan. However, if you decide on an FHA loan and have a down payment of 10% or more, you may be eligible for the removal of mortgage insurance after 11 years.

Differences

Home Requirements

USDA: This loan is backed by the US Department of Agriculture, and is unique in that it is intended to revive and populate rural areas. Though each home must meet a location requirement (it must be in a rural area), you may be surprised at just how much of your state is considered rural. You can check here to see if your area has nearby options for a USDA eligible loan. (Most places do!)

Additionally, USDA eligible properties must have certain utilities like running water and electricity. They must also have access to a road or driveway. Homes must be used as a primary residence, and they cannot be used as a commercial property (like a commercial farm).

FHA: These loans are backed by the US Department of Housing and Urban Development (HUD). HUD’s primary concern when providing housing to lower income families is the safety and health of the homeowners. Therefore, an appraiser for an FHA loan may look for the following things:

  • The foundation is in good condition.
  • Every bedroom has a window (for fire escape).
  • Staircases have handrails.
  • The roof is in good condition.
  • There is no chipped paint (in homes built prior to 1978, due to lead-based paint hazards).
  • The heating system is functioning properly.

Fortunately, the most common issues that arise during an appraisal (chipped paint and the absence of handrails) are relatively cheap fixes that the sellers should have no problem fixing.

Down Payment

USDA: One of the best selling features of a USDA loan is that it doesn’t require a down payment. This means your upfront costs for buying a home are limited to closing costs (which can sometimes be waived or tacked onto your mortgage). You could purchase a house with less than a few thousand dollars cash – a very attractive feature for young homebuyers!

FHA: Although an FHA loan does require a down payment, it’s far lower than the traditional one for a conventional mortgage. Instead of a 20% upfront payment, you are only responsible for 3.5% of the home’s sale price at closing.

Credit Score

USDA: Your credit requirement for a USDA loan is a bit higher than the FHA. Although you can qualify for this loan with a lower score (the government does not set a limit – the lender does), you will typically need a score of over 600 (preferably above 640) to get this loan. Thankfully, if your score is a bit low, there are plenty of ways for you to raise it in less than a year!

FHA: An FHA loan’s most attractive feature is its low credit score requirement. In fact, you can qualify for this loan with a credit score as low as 500. Many lenders will require a credit score of 580, at least, but it is possible to get around this requirement if you are able to put together a larger down payment (10% or higher).

Which One is Right for Me?

When it comes to choosing a loan type, it’s important to speak with a loan officer. They know all the complicated terminology and legalese I mentioned above, and will be able to walk you through the process of buying a home with either of these loan types.

Plus, a loan officer will be able to help you get pre-approved which will increase your chance at finding and purchasing your dream home!

 

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