USDA vs. FHA Home Financing: The Basics
FHA loans are by far the most common type of mortgage guaranteed by the U.S. government, but they’re not the only government-guaranteed loan option on the market. USDA loans actually have lower interest rates, and lower average MIP (0.35% for most loans). However, unlike FHA loans, USDA loans aren’t available for everyone— only borrowers living in rural locations with eligible properties qualify. Plus, income limits also apply to USDA loans. Fortunately, the USDA also has a loan option for those who want to make repairs or renovations to their home without taking out additional financing. Just like the FHA’s 203(k) home purchase and renovation loan, the USDA escrow holdback loan permits borrowers to finance a home and renovations in one, single loan.
USDA Loan and FHA Loan Requirements Compared
We just mentioned that USDA loans have significantly stricter requirements than FHA loans, but just how strict are they? Well, first off, despite the fact that USDA loans do have income limits, they actually require borrowers to have decent credit, with a minimum credit score of 640 required. In contrast FHA loans require a minimum credit score of only 500. Despite that, in practice, very few lenders would dare to offer a borrower with a 500 credit score any kind of loan, and most FHA lenders actually prefer a credit score of at least 620.
Location is perhaps the toughest eligibility factor in regards to qualifying for a USDA loans. In general, USDA loans are restricted to properties in areas with a population that is not larger than 10,000, or a population that is not smaller than 20,000; and is not located in metropolitan statistical area (MSA); and a significant lack mortgage credit for low income and moderate income households. In addition, properties in certain areas that were considered rural on the last few U.S. censuses may still be eligible, as long as they area still has a serious lack of home credit for lower income families. While this may sound incredibly restrictive, it’s not as bad as it seems; approximately 97% of the U.S. falls into a USDA loan eligibility zone, including pretty much all areas more than 50 miles away from a major urban area.
Other than the location restrictions, the income restriction element could be the toughest part of getting a USDA loan. In general, households with between 1-4 members can have a maximum income of $75,650. That income can go up to a limit of $153,400 in certain high income areas. Finally, just like FHA loans, USDA loans do have limits, which, (also like FHA loans) are based upon the area in which a property is located.
Comparing the FHA 203(k) Loan and the USDA Escrow Holdback Loan
FHA 203(k) loans and USDA Escrow Holdback loans are both designed for essentially the same purpose: allowing borrowers to finance both the purchase (or refinance) and renovation of a home in one, single loan. FHA 203(k) loans, like other kinds of FHA loans, offer up to 96.5% financing for borrowers with a credit score of at least 580. In contrast, USDA Escrow Holdback loans offer an incredibly generous 102% LTV financing. Therefore, if a borrower bids at under the home’s value (and the seller accepts), the borrower will have even more funds for home repair.
Just like with FHA 203(k) loans allows borrowers to buy a home that doesn’t meet the FHA minimum property standards, the USDA also offers an option allowing borrowers to purchase a home that does not yet conform to the minimum USDA property standards, giving them the ability to use loan funds to bring it up to snuff. Specifically, the USDA Mortgage Repair Escrow Program permits borrowers to borrow up to 10% of the loan to make repairs. Despite that, this program only allows the borrower and the contractor 30 days in which to make the repairs— which means that a borrower cannot really take a home that isn’t USDA-worthy and significantly renovate it with this loan type.
In Conclusion: USDA Loans May Be More Affordable For Those Who Qualify, But Carry Many Restrictions
In truth, only a very specific type of borrower can quality for a USDA home loan. If that’s you, then USDA financing could be an incredible option, considering the fact that it has even lower interest rates than FHA loans (as well as lower MIP). Despite that, even if you do qualify, USDA home inspections can be a significant challenge, and many homes do not qualify. In most cases, ordinary borrowers who want buy an average home would be better suited to an FHA 203(b) loan, or, if the borrower would like to make home renovations, a 203(k) or Fannie Mae HomeStyle Loan.