There are three government-backed mortgage loan programs available in today’s financing market. VA loans, FHA and USDA. For those veterans and qualified active duty personnel who are VA loan eligible, that program is hard to beat. But the remaining two, FHA and USDA loans, they’re still very attractive options. If you’re considering either an FHA or USDA loan, let’s take a closer look at them both to help clear the air just a bit.
When comparing an FHA loan to the USDA program, we’re going to assume both you and the property you’re considering are USDA eligible. The USDA sets geographical limits as to the location of the property, giving priority to rural and semi-rural areas. Surprisingly, USDA also allows financing in areas that look nothing like a rural area, but you do have to find out first if the property is located in an allowable zone. Second, there are household income limits to qualify for a USDA loan. In general, the USDA loan program restricts the household income of qualified persons to 115 percent of the median household income for the area. There are other, more specific ways to calculate qualifying income but the 115 percent number is a good place to start. Now, that said, let’s compare.
Down Payment Requirements
This is fairly straightforward. FHA loans require a 3.5% down payment from you while the USDA mortgage is a zero money down program. That’s a lot of money, especially for the first time home buyer. On a $300,000 home, the down payment for an FHA mortgage is $10,500.
There is a requirement for mortgage insurance on both loan programs. The USDA loan asks for an upfront premium, called the guarantee fee, of 2.75 percent of the loan which is rolled into the loan amount and an annual premium of 0.40%, paid monthly. FHA’s upfront premium is 1.75 percent of the loan and an annual premium of 0.85 percent. Winner: It’s a close one but because the lower annual premium on the USDA program helps borrowers qualify. USDA.
Mortgage rates for both programs are as competitive as any in today’s environment. USDA rates are typically lower when compared to conventional loans with less than 20 percent down. Conventional rates can be higher for low down payment loan programs in addition to the mortgage insurance premium. FHA rates are similar to USDA rates. Winner: Considering the lower monthly mortgage insurance premium, the edge goes to…USDA.
FHA and USDA loans are offered in 15 and 30 year fixed rate terms. However, these are the only two terms offered by USDA lenders. There are no adjustable or hybrid loans available in the USDA realm and there are such choices for FHA borrowers.
FHA and USDA loans require you to have at least a two year employment history and currently employed. You will be asked to provide copies of your most pay check stubs covering 30 days as well as your last two W2 forms. If you’re self-employed, be prepared to present signed copies of your federal income tax returns as well as a year to date profit and loss statements.
There are no limits how much you can earn when applying for an FHA loan yet there are income limitations for the USDA program. Generally, the USDA limits household income to be no greater than 115% of the median income for the area. Note, there are other considerations when calculating qualifying income such as household size and the nature of those living in the home, among others. But the 115% is a general rule.
Debt to Income Ratios
There no established debt to income ratios for either the USDA or FHA loan. Debt to income ratios, or simply, “debt ratios” are expressed as a percentage of monthly debt compared to gross monthly income. A commonly accepted debt ratio can be as high as 43% when considering all debt but can be higher or lower based upon the borrowers’ overall financial and credit profile.
Debt used to calculate ratios are monthly credit obligations such as a car payment or credit card or child care and any support payments. Debt not used to calculate debt ratios are those devoted to utilities, food and entertainment for instance. Typically, if it’s on your credit report, it’s used.
The USDA doesn’t establish this ratio but most USDA lenders use a total debt to income ratio of 29/41. Again, this is a general guideline, not a rule. The 29 is the total house payment compared to gross monthly income while considers all debt. FHA loans have two debt ratios as well, a housing ratio where only the mortgage payment is used and a total debt ratio. FHA uses a 31/43 guideline. Essentially, if the loan is approved when the lender submits the loan for an automated approval, whatever ratios are used as long as the loan receives an approval the ratios will be accepted. Higher ratios for both loans may be used b
Both programs are fairly similar but the FHA loan program will have higher monthly payments due to the higher mortgage insurance premium. The upfront premium is lower than the USDA loan but not by much. Still, you can’t get around the 3.5% down payment required for FHA loans. If there are gift funds available to cover that down payment that will alleviate this requirement but if there is no gift, that’s an additional $10,500 on a $300,000 purchase price. If the property and the borrowers meet USDA guidelines, the USDA mortgage is the better choice.