USDA loans are for low-income, rural homebuyers, right?
Many homes in the suburbs also qualify for USDA loans, which allow you to buy with no money down. And borrowers with low to moderate household incomes qualify, so more borrowers are likely eligible for these 100% financing mortgages than they realize.
Although conventional loans are the most common types of mortgages, they’re not always the right option, especially for first-time homebuyers who have little money to put down.
Before you buy, it’s wise to evaluate the difference between a USDA loan vs. conventional loan so you can decide which one is right for you.
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USDA loan vs. conventional eligibility
Choosing between a USDA loan vs. conventional borrowing? First, let’s find out how these loans work.
What is a USDA loan?
USDA Single-Family Housing Guaranteed Home Loans* are insured by the U.S. Department of Agriculture (USDA).
Why does this matter to homebuyers? Because USDA insurance enables lenders to offer mortgages to homebuyers with 0% down payments and competitive interest rates, even if they have low to moderate income and imperfect credit.
The USDA does not lend money on Guaranteed Home Loans. USDA-approved mortgage lenders issue the loans, though the USDA has to sign off on a borrower’s application before the loan can close.
There is a second type of USDA loan — the USDA Single-Family Housing Direct Loan — and that one is issued by the federal government. However, those are for very low- and low-income borrowers, and most USDA homebuyers have the “Guaranteed” Home Loans, meaning they are backed by the U.S. government. For the purposes of this article, “USDA loans” will refer to the Guaranteed program only.
What is a conventional mortgage loan?
Conventional mortgage loans are not backed by the government but rather by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
Typically, borrowers need higher credit scores and potentially more income stability and lower debts to qualify for a conventional loan. Some conventional loan programs allow you to buy a home with a 3% down payment.
Although the minimum credit score for a conventional loan is 620, borrowers who have credit scores under 680 may be better off with a USDA loan or another government loan program, such as an FHA loan or VA loan.
Conventional borrowers with scores under 620 may receive higher interest rates, since their scores represent higher risks to borrowers. The government programs may have lower interest rates since their credit requirements are more flexible and in some cases geared toward lower credit borrowers.
USDA eligibility requirements
To qualify for a USDA Guaranteed loan, you’ll have to meet these eligibility requirements:
- Geography: USDA loans are only available for certain rural and suburban areas
- Income limits: Borrowers must earn less than 115% of their area’s median income
- Down payment: 0%. You can qualify for a USDA loan with no money down
- Credit score: The minimum credit score for a USDA loan is 620, but the government allows lenders to use their discretion in determining creditworthiness, so some may approve borrowers with lower scores
- Debt-to-income ratio (DTI)*: Your lender will submit your loan through an Automated Underwriting System that will determine the DTI requirement for your specific loan scenario
- Property type: USDA loans may only be used for single-family homes that will be used as a primary residence
*Debt-to-income (DTI) ratio is monthly debt/expenses divided by gross monthly income.
The USDA does not issue loan limits on Guaranteed Loans, so there is no cap on how much a lender is allowed to approve for a USDA loan.
However, loan amounts are naturally constrained by the income limits, your credit score, savings, and debt-to-income ratio. Your lender will review your finances and assess how much you can afford in a monthly mortgage payment and set your loan amount from there.
Conventional loan eligibility requirements
Conventional loans come in several different forms, but the most common conventional loans are conforming loans, which adhere to lending guidelines set by Frannie Mae and Freddie Mac.
To qualify for a conventional loan, you’ll need to meet these requirements:
- Credit score: 620 or higher
- Debt-to-income ratio: Determined by Automated Underwriting System
- Down payment: 3%
One area in which conventional loans have USDA loans beat is flexibility. There are no income or geographic restrictions for most conventional mortgages, so you can use them to buy a home anywhere in the country. (Some 3% down conventional loans come with income limits, though.)
Conventional conforming loans are subject to loan limits, however. The conforming loan limits for a single-family home in 2021 range between $548,250 and $822,375, depending where you live.
Unlike USDA loans, conventional loans can finance any type of occupancy, including vacation homes and investment properties.
The USDA Guaranteed Loan program has strict income limits. You’ll qualify only if your household income falls below 115% of your area’s median income.
The USDA’s online income calculator can give you an idea of whether you’re eligible. But don’t dismiss the possibility of a USDA loan if your household income exceeds the limit at first glance.
USDA lenders calculate household income eligibility after deductions for minor children, childcare, and certain medical expenses. So while your gross income may put you above the limit, you could still qualify once your lender accounts for deductions.
Most conventional loan programs do not have income limits. However, some programs — such as Fannie Mae HomeReady and Freddie Mac HomeOne — are the exceptions. These programs allow down payments as low as 3%, but only borrowers who earn no more than 80% of their area’s median income can qualify.
Yes, USDA loans are available only in certain areas, but you may be surprised by how many of those areas there are.
Most of the Continental U.S. meets the USDA’s definition of rural. Many suburbs within an hour’s commute of major cities qualify for USDA loans as well, so you don’t have to move to a small town or sparsely populated area to get one of these loans.
Conventional loans can be used in any location; there are no geographic limits.
Conventional loan limits explained
We noted earlier that USDA Guaranteed Loans do not have loan limits, but conventional conforming loans do. That said, you can likely get a larger conforming loan than with USDA due to the former’s income limit.
Conventional loan limits are $548,250 nationwide, and higher in many areas. USDA loans above $400,000 are few and far between thanks to income limits that top out around $100,000 per year even in expensive locales.
So it’s worth understanding a bit about conforming loan limits and how they apply to your home purchase.
Each year, the Federal Housing Finance Agency (FHFA) sets loan limits throughout the country based on the median home prices in a given area.
So home shoppers in New York City, Denver, Los Angeles, or Seattle can borrow more than shoppers in, say, Keith County, Nebraska, or Coconino County, Arizona.
To borrow more than the allowed loan limit in your area, you’d need a non-conforming or jumbo loan, which tends to require more money down and a higher credit score.
2021 Conventional loan limits
|Property type||Contiguous States; Washington, D.C. & Puerto Rico||High-cost areas, Hawaii, Alaska, Guam & the U.S. Virgin Islands|
Some counties’ loan limits fall between the annual minimum and maximum limits shown above.
In Monterey County, California, for example, a conforming loan on a single-family home can go as high as $739,450. In Fairfield County, Connecticut, the limit is $601,450.
Down payment requirements
USDA loans require no money down, though you can put money down if you don’t receive an approval at zero down. Doing so may help you get approved, since there’s less risk to the lender.
Conventional loans require at least 3% down, and you may need to put down more than to get a good interest rate. Here’s what that might look like depending on your purchase price.
|Home price||3% down||10% down||20% down|
The higher the home price, the more money you’d need to put down on a conventional loan. With a USDA Guaranteed Loan, a loan of any amount requires no down payment.
Since a USDA loan can get you into a home with less money out of your pocket, there’s got to be a catch, right?
USDA loan mortgage insurance vs. conventional PMI
There is one, kind of. USDA loans require an upfront mortgage insurance fee of 1%, which you may be able to roll into your loan, and an annual fee of 0.35%.
On a $250,000 home, these fees would be $2,500 at closing and about $900 in annual premiums during the first year. As your loan balance goes down, the annual fee would decrease, too, as it would be recalculated every year.
Conventional loans require mortgage insurance as well, if you put down less than 20%. You’d owe private mortgage insurance (PMI), which gets broken down into your monthly mortgage payment, until you reach 20% home equity. PMI could cost anywhere from 0.5% to 2% of your loan amount each year, paid in 1/12 installments with each payment.
This is where USDA might save you some money. On a $300,000 loan amount, conventional PMI at 1% annually will cost about $160 more per month compared to USDA mortgage insurance.
The USDA mortgage insurance requirement remains in place for the life of the loan, whereas the conventional requirement ends at 20%. But you can refinance a USDA loan to a conventional loan when you have 20% equity, so you can take advantage of low upfront costs on the USDA loan and the conventional mortgage’s more attractive mortgage insurance rules.
Just keep in mind that a refinance could cost thousands in closing costs. If you want to ditch mortgage insurance someday without a refinance, choose conventional.
You can use a conventional loan for many property types and uses. Single-family residences, 2-4 unit homes, condos, and townhomes are fair game. You can also finance a vacation or second home with a conventional loan.
USDA loans are designed to finance your primary residence, and it must be a single-family home. Unlike conventional, FHA and VA loans, you cannot buy a multifamily home with a USDA loan.
The USDA also has a few property guidelines you should know about:
- Property size: Home must be between 400 and 2,000-square-feet
- Utilities: Plumbing and electrical systems must work properly and the home must have access to water and wastewater services
- Property use: You can’t buy a property with lots of acreage that could be subdivided or leased to a business or industry
The USDA also mandates that the homes it insures are “modest and residential in nature.”
Appraisals & approvals
For a USDA loan to be approved, the home you’re buying must meet strict property requirements. Most of the time, the appraisal and approval process goes smoothly.
After all, most people who are shopping for a primary residence don’t want homes that are not structurally safe.
Still, navigating the USDA approval process may take longer when compared to a conventional loan approval if the appraiser flags something for repair before the loan can close.
The USDA must also sign off on your application before your lender can finalize the loan, so it may take longer to close on a home with a USDA loan than a conventional mortgage.
So, which is better — USDA or conventional?
Deciding between a USDA loan vs. conventional loan should come down to your unique needs — assuming you can qualify for both loans.
USDA loans work especially well if:
- Saving is not your strong suit: Skipping the down payment keeps thousands of dollars in your pocket and eliminates the need to save up cash. You can even use gift funds for your closing costs, so you need very little upfront
- Your credit profile isn’t perfect: Although the minimum credit score of 620 is the same for USDA and conventional, the USDA Guarantee can ease a lender’s concerns about your borrowing credentials since the loan is backed by the government
A conventional mortage may be the right fit if you:
- Want a shorter loan term: USDA loans offer 30-year terms while conventional loans offer shorter term options 15-year mortgages.
- Can afford a larger down payment: If you can make a large down payment — especially 20% — you could save more with a conventional loan by avoiding PMI
- Want more flexibility in where you live, since there are no geographic restrictions
USDA loan vs. conventional FAQs
USDA loans are usually better for homebuyers who can’t make a down payment, have limited income, or are buying in qualifying rural or suburban areas. Conventional loans can be great options for borrowers with strong credit, solid income, and who want flexibility in where they can buy.
Not everyone can get a USDA loan. You’d have to meet the program’s income and geographic requirements to qualify. Then there’s the USDA’s upfront and annual mortgage insurance fees. These fees are not excessive, but unlike a conventional loan’s mortgage insurance, they can’t be cancelled unless you sell the home or refinance when you have 20% home equity.
Yes. If your USDA loan helps you become a homeowner sooner, it can be worth it. These are 0% down payment loans that make homeownership accessible to people who might otherwise have to wait years to qualify.
No matter what kind of loan you’re using to buy your new home, the first step will be getting preapproved to find out what types of loans you qualify for and which is best for you.
*USDA Guaranteed Rural Housing loans subject to USDA-specific requirements and applicable state income and property limits. Fairway is not affiliated with any government agencies. These materials are not from USDA or RD and were not approved by USDA or RD or any other government agency.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.