FHA vs. USDA: How these government-backed loans stack up

Both FHA loans and USDA loans make qualifying for a new mortgage easier. Both loan types depend on government insurance to make this happen.

And that's about where the similarities between these loan types end.

Borrowers who are deciding between USDA and FHA loans should learn the strengths and weaknesses of each program. Then they can pick the loan type that best matches their homeownership needs. 

FHA vs USDA loans: At a glance

Built-in federal insurance protects the private mortgage lenders who underwrite FHA and USDA Guaranteed loans. This allows lenders to extend credit to more homebuyers.

What is an FHA loan?

Anyone buying a home in the U.S. can apply for an FHA loan. The FHA sets no income or location rules. 

FHA loans feature insurance from the Federal Housing Administration (FHA). With federal insurance protecting the lender, borrowers can:

– Make lower down payments: 3.5 percent down is the minimum required for FHA borrowers.

– Qualify with lower credit scores: FICO scores as low as 580 can still get approved for FHA borrowing with 3.5 percent down.

– Still get competitive interest rates: Even with a lower credit score and a small down payment, borrowers may still qualifiy for competitive interest rates, thanks to the FHA insurance. 

Some lenders will extend credit even further. For example, with some lenders, borrowers with credit scores as low as 500 could get approval if they put 10 percent down. Not all lenders will do this.

What is a USDA loan?

Home buyers with moderate incomes in rural areas can apply for USDA loans. The U.S. Department of Agriculture guarantees USDA loans.

The biggest attraction for borrowers? Zero down payment. Home buyers can put $0 down and still buy a home with the USDA guarantee backing them.

The USDA operates two loan programs:

• Single Family Direct Loans: Very low-income applicants can borrow directly from the USDA.
• Guaranteed Loan Program: Borrowers with moderate incomes apply for loans with private lenders who get the USDA's backing.

"Moderate income" means you must earn 115% or less of your area's median income to be eligible. "Rural areas" include some suburban neighborhoods outside major cities.

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FHA vs USDA loans: Eligibility and borrower requirements

Though their goal is the same, to put more Americans in homes of their own, FHA and USDA loans accomplish this goal in different ways and for different types of borrowers.

FHA vs USDA loans for borrowers with credit score challenges

FHA loans level the playing field for borrowers with credit challenges. Even borrowers with FICO scores of 580, 40 points below the 620 required for conventional loans, can get FHA approved with only 3.5 percent down.

USDA loans typically require higher credit scores. Many lenders require FICOs of 640 or higher for USDA borrowers, though it is possible to find lenders who allow scores of 620.

FHA vs USDA loans for income limits and DTI ratios

To apply for a USDA loan borrowers must earn 115 percent or less of their area's median income. You can find your area's median income with this tool. FHA loans are open to people of all income levels.

Since USDA loans go to people with moderate incomes, USDA lenders usually have stricter debt-to-incone ratios (DTI) rules. Typical USDA lenders cap DTI at 41 percent. That means the borrower can spend up to 41 percent of their gross monthly income on debt, including the new mortgage. Some may be stricter depending on the borrower's income level.

Typical FHA loans allow borrowers to spend up to 43 percent of their gross monthly income on debt, including the new house payment. And since FHA borrowers can earn higher incomes, lenders may be willing to push this DTI cap to 45 percent or beyond for some borrowers.

USDA vs FHA loans for location and property type

FHA loans also work with more property types, including multi-family homes that have up to four units. (The borrower must live in one of the units.) USDA loans focus exclusively on single-family homes.

USDA loans work only in USDA-designated rural areas, which include many suburban neighborhoods. Your property must be modest in size and design and serve as your primary residence.

You can use FHA loans almost anywhere in the United States. The property must meet HUD's health and safety standards. You must use the home as your primary residence.

Cost differences between USDA loans vs FHA loans

FHA loans help home buyers overcome credit challenges. USDA loans open doors for moderate earners in rural areas. 

A borrower who qualifies for both types of loan and is still on the fence should compare the cost differences between USDA loans and FHA loans.

FHA vs USDA down payment requirements

The down payment is the most noticeable cost difference. USDA loans require no money down. FHA loans require at least 3.5 percent down. For someone buying a $300,000 home, 3.5 percent down is $10,500 down.

The winner: USDA loans.

Mortgage insurance premiums and guarantee fees

Borrowers help pay for the insurance that makes USDA and FHA loans work in upfront and annual fees. The annual fees are broken into 12 installments and added onto each monthly payment. 

FHA loans charge:

– An upfront premium of 1.75 percent of the loan amount
– An annual premium (0.55 percent of the loan balance for most borrowers) 

FHA mortgage insurance (MIP) stays on the loan until its paid off unless you put down 10 percent or more down. In that case, the coverage expires after 11 years of payments.

USDA home loans call this mortgage insurance a "guarantee fee." The USDA requires two guarantee fees:

– A 1% upfront guarantee fee
– A 0.35% annual fee 

The winner: USDA loans whose fees are lower.

Maximum loan amount for FHA vs USDA loans

The maximum size of an FHA loan is bigger than the maximum size of a USDA loan. In most areas, FHA loans can reach up to $524,225 for single-family homes. The USDA typically limits loans to $419,300.

Both USDA and FHA loan limits fall below conventional loan limits.

The winner: FHA loans

FHA vs USDA loan: Other differences

Here are some other differences between USDA and FHA loans that can help some borrowers decide:

• Loan terms: FHA loans offer 15- and 30-year terms, usually with fixed interest rates. USDA loans offer only 30-year terms.
• Streamline refinances: Both loan types allow streamline refinancing which can lower the loan's interest rate without paying full closing costs. 
• Availability: More lenders provide FHA loans, but many also offer USDA Guaranteed.
• Appraisals: Both loan types have their own appraisal process which makes sure the home meets minimum property requirements.
• Seller concessions: Both loan types allow sellers to pay up to 6 percent of the loan amount in closing costs (if the buyer agrees). USDA lenders could allow some borrowers to roll some of the loan's closing costs into the loan amount, lowering upfront costs even more.

A mortgage preapproval can show how different loan types would play out for individual borrowers.

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Pros and cons of each loan type

FHA loan pros and cons

USDA loan pros and cons

FAQs: USDA vs FHA loans

Which loan is better for first-time homebuyers with limited savings?

USDA loans are better for many first-time homebuyers with limited savings since they require no down payment. But FHA loans may be more suitable if you don't meet USDA's location or income or credit score requirements. FHA allows down payments as low as 3.5% with credit scores of 580 or higher.

How do credit score requirements differ between FHA and USDA loans?

FHA loans can be a lot more flexible with credit scores, possibly approving borrowers with scores as low as 500 (with a 10% down payment) or 580 (with a 3.5% down payment). USDA loans typically require a minimum credit score of 640, although this is set by lenders rather than the government.

Are there location restrictions for FHA and USDA loans?

FHA loans can be used to purchase properties almost anywhere in the United States. USDA loans, however, are restricted to USDA-designated rural and some suburban areas, limiting their availability based on location.

How do mortgage insurance costs compare between FHA and USDA loans?

FHA loans have higher mortgage insurance costs, with an upfront premium of 1.75% and an annual premium of typically 0.55% to 0.85%. USDA loans have lower costs, with a 1% upfront guarantee fee and a 0.35% annual fee, making them potentially more affordable in the long run.

Can closing costs be financed with FHA and USDA loans?

USDA loans allow borrowers to finance closing costs into the loan amount, effectively borrowing above the home's value. FHA loans typically don't allow this, but they do permit seller concessions, where the seller may contribute towards closing costs.

The best loan type lines up with your unique journey

Choosing between FHA and USDA loan means comparing fees, eligibility rules, and monthly payments.

Ultimately, the best loan for your homeownership journey will be the loan that best fits your needs.

Getting a mortgage preapproval can also help you compare borrowing costs.  

...in as little as 3 minutes – no credit impact