Is A Conventional Or USDA Loan Better?

What’s a better loan program for homebuyers: conventional or USDA?

Rule of thumb: Conventional is better for someone with at least 5% down and buying in or near urban areas. USDA is better for those without much savings, moderate income, and buying in a rural or suburban area.

Here’s more detail.

Geography: Winner - Conventional

USDA loans are limited to rural areas. This designation is not as restrictive as you might think. In fact, one study found that 97% of U.S. land area is eligible for USDA loans. Many eligible areas are just a few miles from downtown cores.

Still, eligible areas might be outside of comfortable commuting distance for your job or social activities, especially in larger cities.

Conventional loans, on the other hand, are available in rural, suburban and urban areas. The property only has to be within the 50 states, District of Columbia, Puerto Rico, Guam, or the U.S. Virgin Islands.

Income Limits: Winner - Conventional

Another restriction for USDA loans is income level. Income limits are set at 115% of the typical income for the area, or "area median income". This is a fairly generous limit, though.

In most areas, you can make up to $112,450 annually. Higher-income areas, such as parts of Alaska, allow incomes of nearly $200,000 per year.

Still, many dual-income or multi-generational households with three or four incomes might make too much. Most conventional loans do not have income limits, except for some 3% down programs.

Down Payment: Winner - USDA

USDA loans do not require a down payment. You can finance 100% of the home’s purchase price.

Conventional loans require at least 3% down. But you’ll get the best rates and terms with 5% down.

USDA is the clear winner for those without a lot of money saved up for a down payment.

First-Time Buyer Requirement: Winner - Toss-Up

You don’t need to be a first-time buyer for a standard conventional loan or USDA.

However, some 3%-down conventional loan programs like Freddie Mac HomeOne® and Freddie Mac Home Possible® require at least one borrower on the loan to be a first-time buyer.

Mortgage Insurance: Winner - USDA

Conventional private mortgage insurance (PMI) will probably be more expensive than the USDA “Guarantee Fee” (USDA’s version of mortgage insurance).

Plus, conventional PMI rates are highly dependent on credit score and down payment.

For instance, someone needing a $300,000 loan with a 740 credit score and 5% down would pay just $132 per month. But someone with a 650 score with 3% down would pay $412 per month.

Compare that to USDA: Either borrower would pay just $87 per month.

However, the monthly USDA Guarantee Fee has drawbacks as well. It is not cancelable when you reach 20% equity in the home as is conventional PMI. Additionally, you must finance or pay out of pocket a 1% upfront fee for USDA. In the above example, that’s an extra $3,000 financed into the loan.

Credit Score: Winner - USDA

The conventional credit score minimum is 620. Some USDA lenders will accept applications down to 600 or lower.

Additionally, USDA is more forgiving when it comes to past credit issues. And, those with lower credit will pay lower mortgage rates and mortgage insurance by choosing USDA.

One final note: Those with no credit score may have an easier time getting approved with USDA. Many USDA lenders accept non-traditional credit verification, such as proof of on-time payments of rent, utilities, insurance, and other regular expenses.

Debt-To-Income: Winner - Toss-Up

Both conventional and USDA loans allow a debt-to-income (DTI) ratio up to about 45% with compensating factors like good credit or extra reserves after closing.

Certain DTIs may be approved by USDA but not for conventional, and vice-versa, depending on the rest of the loan file.

However, the program that’s most lenient about DTI is FHA, which allows DTIs up to the mid 50% range for some scenarios.

Mortgage Rates: Winner - USDA

According to Optimal Blue, a mortgage software company that tracks rates in real-time, USDA loan rates were about 0.25% lower than conventional ones, assuming a conventional loan with less than 20% down and a credit score of 720.

USDA loans are backed by the United States Department of Agriculture to encourage economic development in rural areas. Conventional lending is more geared toward profit and secure interest income for the eventual investor.

Because USDA loans are backed by the federal government, they come with more lenient guidelines and lower rates.

Buying a Vacation or Rental Home: Winner - Conventional

One area where conventional loans beat USDA is when you want to buy something other than a primary residence.

USDA loans can’t be used to buy a vacation property or rental. You must be purchasing a home you plan to live in. Conventional loans can be used to buy a primary residence, second home, or investment property.

Which Loan Will You Choose?

Both conventional and USDA loans are fantastic programs for the right situation.

If you need help deciding, contact a lending professional to work up a side-by-side comparison for your home purchase.