The FHA and USDA loans both offer flexible guidelines to help you purchase a home. If you qualify for both programs, how do you decide between the two?
We help you understand the pros and cons of each loan below.
The FHA Loan and Its Benefits
First, let’s look at the FHA loan.
Backed by the FHA, this loan offers borrowers the chance to secure financing with average credit and a low down payment. The benefits in particular include:
- You only need a 580 credit score. That’s 60 points lower than the credit score required for USDA loans. It’s safe to say that you can have ‘fair’ credit and still get an FHA loan. This makes it good for borrowers with less than optimal credit.
- You can have a credit score as low as 500 and still qualify. In this case, would need a 10% down payment, but if you have the money, it’s a great way to get the financing that you need.
- The entire down payment can be a gift. As long as you have a credit score over 580, 100% of your down payment can be a gift. If you have a credit score between 500 and 579, 3.5% of the 10% down payment must come from your own funds and the remainder can be a gift.
- Sellers can pay as much as 6% of the purchase price of your home to help you with your closing costs.
- The FHA is generous with its debt ratio guidelines. You can have a 31% housing ration and a 41% total debt ratio.
The Disadvantages of the FHA Loan
While FHA loans do have a lot of benefits, there are certain downsides that you should know:
- You need a down payment. Unlike the USDA loan that offers 100% financing, you have to come up with at least 3.5% of the purchase price of the home for a down payment.
- The mortgage insurance rates on FHA loans are 0.5% higher than the mortgage insurance rates on the USDA loan.
- You have to pay mortgage insurance for the life of the loan. Even when you owe less than 80% of the home’s value, you still pay mortgage insurance.
The USDA Loan and Its Benefits
The USDA backs the USDA loans. This loan works a little differently than the FHA loan. If you are eligible for the program and you qualify for the loan, it’s often the less expensive option.
The benefits of the USDA loan include:
- You don’t need a down payment. The USDA allows you to borrow up to 100% of the home’s value. The only thing you have to cover is the closing costs.
- The USDA allows sellers to contribute up to 6% of the sales price to help you with your closing costs and other fees.
- USDA loans have a much lower mortgage insurance rate of 0.35% per year, versus the FHA’s annual mortgage insurance of 0.85% per year.
- You can have debt ratios as high as 29% for the housing ratio and 41% for your total debt ratio.
The Disadvantages of the USDA Loan
Just as the FHA loan has disadvantages, so does the USDA loan. They include:
- Your total household income cannot exceed 115% of the average income for the area. This includes the income from all adults living with you, even if they aren’t on the loan.
- You must purchase a home within the USDA boundaries in order for it to be considered a rural home.
- The credit score requirements are much higher than the FHA requires. You need at least a 640 credit score.
Which Loan is Right for You?
Now that you know both sides of the FHA and USDA loan, it’s time to figure out which one is right for you. As we discussed above, the USDA loan is usually the first choice simply because you don’t need a down payment and it has lower mortgage insurance.
Before you choose, though, consider the following questions:
- Do you have the credit score to qualify for the USDA loan? (640 credit score)
- Do you have the debt ratios that are low enough to meet the 29/41 requirements?
- Are you comfortable living in a rural area?
- Is your household income low enough to qualify?
If you answer ‘no’ to any of these questions, you may be better off with the more flexible FHA loan. If you answered ‘yes,’ though, you are well on your way to owning a home with USDA financing.