FHA Loans vs USDA Loans (2021) - Which Is Better For You?

Certified Mortgage Advisor
NMLS 1701021
Published 
December 14, 2020

Which one is the best loan for you

We're talking about FHA versus USDA loans and which one is going to be the better one for you? Because if you choose the right loan, you're going to see a savings of around $40,000.

With this blog, I'll show you a chart breakdown of three different types of loans. So we'll do USDA loans, one FHA loan, so I can get an idea of which is going to be the best option for you.

Overview between these two loans

Just a quick background is these are government loans. So there are traditionally four main types of loans. There's a conventional loan, FHA, USDA, and VA. We're going to talk about these two main government loans here. So you do not have to be a first-time buyer with either of these loans. A lot of people think you do, especially with FHA because it's more advertised to first-time buyers.

And these are government-sponsored their government backs mortgages. And what that means is basically anybody who purchases these loans on the secondary market actually has insurance provided by the government in case of a default. So long story short, what that means is these are safer loans for investors because they have this government backing to them.

Not for investors

Also, they can only be for a primary residence. So if you are an investor, this is not going to work for you, unfortunately. These are only if you're going to live in the property and you need to live in there for a minimum of one year.

USDA

Now, USDA is a little bit different than FHA because it's technically a loan for rural properties, but it's not for farms or mixed-use. So it can be a little bit confusing here. Really an FHA is a standard loan. That's going to work in all of the US.

FHA

USDA is only going to work in rural areas. And we'll talk about the map with that as well, but FHA is kind of an overview it's mainly for low credit scores, buyers with credit issues, and it's a lot easier to qualify for than most other loan programs.

What is USDA Guaranteed?

USDA has no down payment, it's for rural areas, and they're actually two different types. There's a direct and guaranteed. So, we're only talking about USDA guaranteed. Guaranteed is what most lenders can offer you with a USDA loan. Direct is directly through USDA, and that's more for a low income and there also is some subsidy that you can get with that program. It's also a lot more difficult to qualify for, and again, only USDA provides it. No other lenders can, but USDA guaranteed, a lot of lenders can provide this for you.

Credit Score

USDA has no down payment, it's for rural areas, and they're actually two different types. There's a direct and guaranteed. So, we're only talking about USDA guaranteed. Guaranteed is what most lenders can offer you with a USDA loan. Direct is directly through USDA, and that's more for a low income and there also is some subsidy that you can get with that program. It's also a lot more difficult to qualify for, and again, only USDA provides it. No other lenders can, but USDA guaranteed, a lot of lenders can provide this for you.

GUS

GUS or Guaranteed Underwriting System is a USDA is underwriting software, and basically, this is something that you'll never interact with. Most of the time, people don't even know that their loan has been underwritten through GUS.

But basically, if you have a below a 640, you have to do a manual underwrite. That means it's going to be a lot more difficult to qualify for a USDA loan. If you have less than 640. So lower debt to income ratio. So you won't be able to afford as much house, but if you have a 640 or higher, you can have access to this underwriting software, which allows you to get approved for more through USDA.

Rates

Now let's talk about the rates. Rates between both of them are actually going to be very similar. Anytime I've priced out the difference between these two, they are the exact same rate. Now lender to lender, they might be a little bit different, but you should be seeing very similar rates again because of their government backs, and you're going to see best rates at 640 plus.

Brokers gives better for government programs

There seems to be this bracket with government loans, when you hit a 640, all of a sudden you're going to see better interest rates, and brokers tend to have better pricing and better rates on government loans than maybe some other lenders would. So it's absolutely worth getting a quote from our broker. The reason why is actually because of the difference with the laws that are created specifically around brokers, that don't constrain other types of lenders and this makes sure that brokers actually have to pass on savings to you legally where banks don't have to. So a long story short, brokers tend to have better rates on these government programs like FHA and USDA.

Credible

That being said, let's go into a quick word from our sponsor. So our sponsor is Credible. They're a mortgage comparison website. What we can do is go on their website: https://www.credible.com/a/state-licenses/ and fill out a form. It takes only a few minutes. They'll do a soft credit pull, so it won't affect your credit score.

And then you can see all of the rates that you're pre-qualified for from different lenders and compare them to find, which is the best option for you. So it's easy, it takes only a few minutes. Something to know is credible does pay to Win the House You Love in advertising fee if you do fill out a prequalification form, and again, that's Credible Operations, Inc. NMLS 1681276.

Credit Events

Now let's talk about credit events. So both of these loans are actually really lenient on what we call credit events. And so these are things like bankruptcies and foreclosures. So these things can trip you up a lot through the loan process.

Chapter 7

So FHA and USDA are very similar in they're actually pretty much identical in what they allow for credit events. So both on a Chapter 7 Bankruptcy, you're going to wait two years from a discharge.

Chapter 13

Chapter 13 bankruptcy, you need a one-year of on-time payments and court approval. Foreclosure, you need to wait three years from the deed transfer date.

Derogatory Credit

Then also for both of these are gonna want to have no major derogatory credit in the past 12 months and derogatory credit would be something like a 90 day, or multiple 60-day late. If you have one 30 days late, maybe two 30 days late, most lenders are going to be able to approve that for you on FHA and USDA.

But if you start getting into more than that becomes a major derogatory credit is going to be a lot more difficult for you to get approved with those late payments.

Debt-to-Income Ratio

Now let's talk about debt to income ratios. So this is going to directly affect how much house you can purchase.

Front-End Ratio

Let's first talk about FHA. So FHA has a front-end ratio of 36.99%. And a front-end ratio is basically your gross income monthly multiplied to front-end ratio is how much housing payment you can have directly. So let's say we had a $70,000 per year income, which would translate into a max housing payment of $2,157.

On USDA, the max front-end ratio is almost 34%, which translates into a maximum prepayment of $1,982. So we can see the difference in price and how much we can afford. It's about a $15,000 difference in purchase price between these two programs. So if you need a little bit more wiggle room, then FHA is probably going to be your better option to get approved for more.

Bank-End Ratio

Then, you also have these backend ratios. The backend ratios are your new housing payment, plus the amount of debt that you have. FHA is a lot more lenient if you have higher credit or if you have a higher debt that you're trying to fit in your debt-to-income ratio monthly.

Loan Limits

Now loan limits. FHA has a loan limit lookup tool: https://entp.hud.gov/idapp/html/hicostlook.cfm. So there are loan limits based on the county and there are high-cost areas. It's pretty standard roughly 90% of the US but then you do have some of those higher-cost areas that do allow you to get a higher loan amount with these FHA loans. And then USDA does not have a loan limit, which is awesome. The only downside is they have an income limit.

Down Payment and Closing Costs

So with FHA, a 500 credit score and above you need 10% down, a 580 credit score and above, you need three and a half percent down as a minimum. On USDA, 500 credit score and above with 0% down. So this is really great if you're trying to save money on your down payment if you don't want to put a down payment down to USDA is going to be your best option.

Upfront Mortgage Insurance

Now both of these loans do have a form of upfront mortgage insurance. And this is wrapped into your loan amount. So FHA charges 1.75% in what they call upfront mortgage insurance premium. USDA charges 1% in what they call a funding fee. Both of these, most of the time are wrapped into your loan.

For instance, on an FHA loan, let's say you had a hundred thousand dollar loan. It's going to turn into $101,750. USDA, if you take out a hundred thousand dollars base loan, your total loan is going to be $101,000 because of the funding fee being financed into the loan. The higher your loan amount is the higher, those amounts are going to be that is financed into your loan amount. So it's something you have to be careful about here. And then all other closing costs are going to be normal. So with these loans, you're still going to run into the standard things that you run into on all other loans.

So you have your appraisal, your title fees, you have taxes, insurance, recording fees. Those are all going to be the same with every single loan. Keep in mind that USDA, even though it says 0% down, that's 0% down payment. You still have closing costs. So you still will have to bring money to the table if you're paying for all of your closing costs up front with a USDA loan. So just be careful about that.

Seller credits

So both these loans have a max limit on how much you can ask the seller for in credit to pay down your closing costs. And this is 6% of the purchase price for both days. So if you're purchasing a $200,000 house, you can ask the seller to pay up to $12,000 towards closing cost.

Now the likelihood of your closing costs ever being $12,000 is very far out. Most of the time you're not going to run into closing costs that are that significant here.

Special requirements and Features

So FHA is most known for having the ability to partner with down payment assistance programs, and these programs tend to be local. On a local level, you'd have to find those around your area, but FHA is the most lenient program in allowing down payment assistance to help you with your initial upfront costs when purchasing a house.

USDA is a little bit more tricky. A lot of people don't know about USDA or they're just afraid of USDA because it has some of these little quirks that we have to watch out for here.

Location Limit

So the first thing is there is a location limit. But USDA is only for rural areas and they determine this by population size. So it doesn't mean it's only for farms. Because USDA actually doesn't work for a working farm which is kind of confusing. It's only for rural areas.

Income Limit

Also, there's an income limit for a household. It tends to be around the upper end of the median area income. So normally what I see is somewhere around 80 to $90,000, and this is household income and the household Bart is a thing that trips up most people because it's your household as a total, let's say the limit is $88,000.

If your household, anybody above the age of 18. Combined is making more than that, then you're not going to be able to qualify for that USDA loan. So this is where you have. And this weird mix of there's no loan limit, but there is an income limit. And so that kind of puts an artificial loan limit of sorts because you can't purchase a huge home, still fit in debt-to-income ratio while being under the income limit.

So most of the time, USDA home will probably go somewhere around the $300,000 range near the upper limit. You might be able to get squeeze in a little bit more, but that tends to be pretty common for what I see is the top end of USDA, where FHA can go a lot higher in some of these higher-cost areas.

USDA Benefit

A huge benefit of USDA that so many people don't even realize is there's one way to wrap closing costs into the loan. Before the housing crash, there used to be programs where you could wrap closing costs into what seemed like any loan, and that's actually, what kind of helped lead to the housing crash.

USDA still allows us provision in kind of an interesting way. So let's say that you purchase a home for $200,000, but it appraises for $205,000 because the appraisal is higher by $5,000. You can wrap up to $5,000 of your closing costs into your loan amount. This is only if the appraisal is higher than the purchase price. This is the only loan program that does that, but most people don't even know that this exists. So it's something great to keep in mind.

Again, we talked about this before there is guaranteed versus direct. Direct is only through USDA. It's going to be a lot longer of a process, a lot more complex, but it is for low income. Households versus guaranteed can be offered by any broker, bank, credit union, direct lender. It can be offered by anyone.

What is commitment review?

People get tripped up with USDA because there is a commitment review, which is confusing because what has to happen is your mortgage lender is going to approve you, but then that's not the end of the story. They have to send that loan to USDA for their review. Then someone at USDA has to actually audit the file, look through it and then issue a second approval.

They're basically auditing the file to see if it meets USDA standards, which can be a little frustrating because there's actually a turn time on this and you can look this up. You can Google "Ohio USDA turn times" and see how long it takes. In a normal market, this might be somewhere around two days in a crazy market like we're in right now, I've seen this take up to 10 days, sometimes even two weeks for USDA to issue their commitment on these loans. So basically the lender approves you, then they send it to USDA. Then USDA approves you, and that's when you have your final clear to close. So that's one little weird thing with USDA.

How about FHA?

FHA-approved underwriters who have the ability to sign off on that loan being clear to close where it has to be sent to USDA. It's a dumb process.

Appraisal

So with the appraisal standards on these are both the same for the most part. The Government programs, USDA, VA, FHA have stricter requirements than conventional does because they're government-backed. So they're mainly concerned with health and safety, structural soundness protecting the property value.

So the best way to think of it is, think of something that's going to be moving ready. That's going to be the best for both of these types of programs, FHA and USDA. Again, there's stricter than conventional because they're government-backed.

Examples of things you need to watch

Would be broken glass, chipping paint, plumbing issues, exposed wiring broken or damaged HVAC systems, rotting, wood, and a wet basement or crawlspace. Those are very common issues that I see. The most common one is chipping or peeling paint. I can't tell you the number of appraisals that have come back needing repairs done just because there's chipping paint. It's not that hard, you just have to sand it and repaint it.

Save yourself from hassles

But I see that tripping up so many appraisals, and then what has to happen is you have to repair it and then have an appraiser go back out and they have to charge a final inspection fee, which is normally somewhere around $150 to $200 just to check if that work was done. So save yourself the hassle of that, make sure those things are completed.

Mortgage Insurance

Both of these loans do have mortgage insurance, and for the most part, they're going to stay on there for the life of the loan. With conventional loans, you're going to see mortgage insurance drop off when you hit 20% equity.

FHA's Mortgage Insurance

So FHA has 0.8, 5% yearly mortgage insurance. So on a $300,000 loan, that's $212 per month. Then they also charge 1.75% upfront mortgage insurance, as we talked about earlier. So in a $300,000 house, that's 5,000, $250 extra. So you make sure you keep this in your mind when you're using a program like this because you immediately took an additional $5,000 fee that FHA charges and put it into your loan simply for using this loan.

So when you need to go sell the property, that has to be paid back. Because it's in your loan amount now, or if you pay it until the life of the loan, you're going to end up paying off that $5,000. So just keep that in mind that it does increase your loan amount quite a bit.

Then FHA does have this rule that if you put 10% or more down, that mortgage insurance will fall off after 11 years. It doesn't do the 20% equity-like conventional loans do. But if you do the minimum down payment or if you do less than 10% down, mortgage insurance is going to stay on for the life of the loan, unless you refinance it into a conventional loan and you have 20% equity.

USDA's Mortgage Insurance

USDA is 0.35% yearly insurance, which is $87.50 per month. You can see this huge difference between the mortgage insurance costs of both of these. Also, 1% funding fees on a $300,000 loan, $3,000, and this stay on for the life of the loan. Even if you do put a down payment on it, doesn't matter what you put on. You can do a 20% down payment on USDA. You're still going to have mortgage insurance, and it's going to stay on there for the entire duration of the loan.

Seller's Perception

Now let's talk about seller perception because when we're using loans we have to keep in mind how the seller is going to perceive us using that loan specifically.

FHA loans are seen as slower than conventional, and it's really not that true. FHA can be a little bit slower, but with both these loans, FHA and USDA, I've closed both of these loans in 10 days from start to finish. So they don't always have to be slow. Appraisals are also seen as pain because they stick with the homes for four months and they have all those requirements that we talked about earlier that are more strict than conventional. So with it sticking for four months, if you get an appraisal today and let's say it comes in short, the seller can't have another FHA buyer come in and get a new appraisal for another four months because that first appraisal value will stick there for 4 months.

USDA is seen as uncommon by a seller. So they might be a little more hesitant to once go with an offer that has USDA unless their agent explains it to them well. So knowing that these loans are both perceived as a little bit worse than conventional or slower, more of a process, conventional helps you realize that if you're going to put in an offer with one of these two loans, it's can still get accepted.

We see tons of offers accepted with FHA and USDA. You just have to make sure that the rest of your offer is attractive. Maybe more so attractive than if you were putting in a conventional offer. So USDA is usually seen as slower than FHA due to the commitment review, right where the loan gets approved.

And then it has to get sent to USDA to get approved a second time. And again, the appraisal can also be a pain and it also sticks with the property for four months.

Loan Comparison

Now let's talk about a loan comparison because I think it's interesting to actually look at these numbers because we're trying to figure out, you can put all this information in your head, but it's hard to actually figure out what do I want to go with?

What I did is I pulled up a $262,000 house around our local area. It's pulling some of these numbers. So here's a monthly cost snapshot. I have three different types of loans. I have an FHA loan, it's 3.5% down. I have a USDA loan at 0% down and then have a USD loan, that's 3.5% down. And the reason I did that is because that's a more fair comparison against the FHA because it's not fair to compare one loan with a different down payment than another loan, right? Because we changed the loan amounts. So of course one's going to be cheaper. So this helps us give a more fair comparison between the two types of programs without the down payment factor.

So FHA total cost would be $1,823, USDA, $1,750 with 3.5%, and these are all monthly costs here. Here's the cost breakdown. So we can see a principal, interest, mortgage insurance and homeowners insurance, and then we can see an estimate of taxes as well.

So FHA tends to have a higher monthly payment because of that higher mortgage insurance that is on the loan. Now I think the best way to actually see the numbers is a total cost snapshot over 30 years. So again, we have the FHA 3.5% down, USDA with 0% down, and then USDA with 3.5% down.

USDA comes cheapest!

We can see over a 30 year period, the cheapest loan is USDA with 3.5% down compared to the FHA loan. This difference here, we can see FHA how much more costly it is. The difference between FHA and this USDA alone is $41,386. That's a huge difference, especially considering the USDA loan had a cheaper monthly payment and we're saving $41,000 over the life of the loan. And the difference here between doing three and a half percent down payment on USDA versus no down payment on USDA is only $5,800 over 30 years. So really a USDA loan can be a fantastic option if you're wanting to put zero down and still come out with a good loan program.

And the only issue is you're just going to have a lot of a tighter box to fit into, right? You need that rural area. You need to be under an income limit. The property needs to meet these requirements you need to fit into that does income ratio limits. It can be a little bit more difficult to qualify for.

What's my choice

If I was going to choose between the two personally, I would go with the USDA option. If I was able to fit into all of those criteria. So if you can fit into all those buckets, USDA is most likely your best option. It's going to save you the most money and provide the most flexibility here. If you can't, FHA is a great runner-up. So I hope this helps you get a good idea between the two of these loans.

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