An FHA loan is a mortgage backed by the Federal Housing Administration. These loans are popular among first-time homebuyers because they can be easier to qualify for than conventional loans. Compared to conventional loans, FHA loans have lower down payment requirements and more flexible credit score criteria. Borrowers are required to pay a monthly mortgage insurance premium to help protect lenders against any losses should a borrower default on the mortgage.
Benefits of an FHA Loan
- Low down payment. Probably the most compelling benefit of an FHA loan is that the borrower's down payment can be as low as 3.5%. This is helpful for those who don't have a larger down payment saved up. It makes a great option for first-time homebuyers.
- Low minimum credit score. FHA lenders realize not everyone has perfect credit. Some lenders will qualify borrowers with a credit score as low as 540. Credit score requirements can vary by lender.
- Low monthly mortgage insurance premium. FHA requires you to pay an upfront mortgage insurance fee as well as a mortgage insurance premium. Many borrowers will be required to pay this premium throughout the life of the loan.
- Fixed rates available. An FHA loan offers fixed mortgages of 15- or 30-year terms. A fixed rate loan means your interest rate will stay the same throughout the life of the loan and your monthly principal and interest payments will not increase.
- Gift allowance. Perfect for first-time homebuyers, the FHA allows a family member to gift the money to you for the entire down payment. Other loans may only allow for a certain portion of the down payment to be gifted. As long as the money is indeed a gift and not a loan from a family member, the consumer will just need to provide the required documentation confirming the amount of the gift.
- Lower debt-to-income ratio. Lenders look to see how much overall debt you have compared to how much income you receive each month to determine how much you can afford to pay for a monthly mortgage payment. Another benefit of an FHA loan is that the debt-to-income ratio requirement is 43%. Other loans, like a conventional loan can be around 36%.
What is a USDA Loan?
A USDA loan is a loan backed by the U.S. Department of Agriculture for low and moderate-income borrowers who are looking for a home in less densely populated rural and suburban communities. A USDA loan is generally not as well-known as an FHA loan, but both allow for a more affordable path into homeownership. You may want to look at the requirements of an FHA loan compared to a USDA loan as there are some differences, but a USDA loan may provide even more financial benefits if your home location qualifies.
Benefits of a USDA Loan
There are many benefits of a USDA loan that helps make homeownership more attainable for those who choose to buy a home in a less densely-populated area.
- No down payment. A huge benefit of a USDA loan is that qualified borrowers can obtain 100% financing, which means they don't need to put any money down towards their mortgage. The only other loan that allows no down payment is a VA loan, which requires military service to qualify.
- Low monthly mortgage insurance. Like FHA loans, there are mortgage insurance fees associated with a USDA loan, which helps to protect the loan in the event of a default. There is an upfront fee and an annual fee for mortgage insurance.
- Lower credit requirements. There isn't a minimum credit score to qualify for a USDA loan, but 640 is a number that is used as a benchmark. Lenders can choose to qualify borrowers below that number when there are extenuating circumstances.
- A high eligibility. While USDA notes that this program is open to buyers looking at "rural" areas, they have a very broad use of the term. This means areas with a population of less than 35,000 people, so that opens the program up to some suburban neighborhoods as well. You'd be surprised as to the areas these loans cover. Check out the USDA website to see if the property or area you are interested in is considered rural or suburban.
- Competitive interest rates. Affordable interest rates are another benefit of a USDA loan. Interest rates for these loans are discounted to allow borrowers to get better than average rates. If you have a higher credit score or are making a down payment, you can get even lower rates.
Comparison of FHA vs USDA Requirements
Here is a quick chart that outlines the FHA vs USDA requirements and benefits and how they compare to each other.
|Funding fee||Not to exceed 3.5% if loan balance||1.75% of loan|
|Annual mortgage insurance||Not to exceed .50 of loan balance annually||Varies (usually between .45 and 1.05 of the loan balance)|
|Minimum down payment||0%||3.5% with a credit score of 580 or better|
|Only available for eligible property areas||Yes||No|
|Income limit restrictions||Yes||No|
|Gift funds allowed||Yes||Yes|
|New home construction||Yes||Yes|
Conclusion: Which Loan is Right For You?
USDA and FHA loans provide an opportunity for buyers who may not otherwise qualify become homeowners through these government-backed programs. There are differences between an FHA and USDA loan, so it's important to compare the loan terms, interest rates, fees, mortgage insurance, down payment requirements and other factors to determine which option best fits your needs.