The biggest difference between USDA loans and conventional mortgages is that USDA loans typically have lower interest rates because the government insures them. The best provider of USDA loans is CrossCountry Mortgage.
Dreaming of wide open spaces? Curious about the best way to finance that country home? There are multiple options at your disposal with varying closing costs, payment requirements, loan options and much more.
Take a look at our guide to compare 2 options for rural home loans: USDA vs. conventional mortgages. Yes, your monthly mortgage payment might turn out roughly the same, but how do these types of loans differ, and what is the mortgage broker really offering you? You’ll also be looking at loan terms, private mortgage insurance, property taxes, etc. How do these loans differ when it comes to your monthly mortgage payment? Are fixed-rate or adjustable-rate mortgages a better option?
What is a USDA Mortgage?
A USDA mortgage is a home loan insured by the Department of Agriculture (USDA). It can be used to buy a home in a designated rural area. Although it might sound like eligible homes are far from urban life, some areas are just a short drive from a city. While these loans are still used for single-family homes, they can greatly improve your financial situation irrespective of the circumstance.
USDA mortgages are offered through private lenders approved by the USDA. USDA loans don’t require a down payment. The only other loan type that doesn’t require a down payment is a VA mortgage, which is a home loan insured by the Department of Veterans Affairs. Remember, the housing market waits for no one, and you want to be prepared, understanding which loan is right for you when you start shopping. The application process may vary.
USDA Loan Requirements
The requirements for a USDA loan include:
- Income. USDA loans have income limits. You must make 115% of the median household income in your area or less. You can check the median income for your area on the USDA website.
- Citizenship. You must be a U.S. citizen, a U.S. non-citizen national or a qualified alien.
- Residency. You must live in the home as your primary residence. You can’t use a USDA loan to buy a 2nd home or an investment property.
- Location. You must buy a home in a designated area. You can look up the addresses of potential homes on the USDA website.
- Credit. While the USDA doesn’t have a minimum credit score requirement, many lenders do. Lenders vary when it comes to their minimum credit score requirements, but many require a 620 or higher.
- Federal programs. You must be in good standing with any federal programs like student loans.
- Ability to repay. USDA loans look at 2 factors to determine your ability to repay the loan. Lenders look at your potential monthly house payment, which can’t be more than 29% of your monthly income. Lenders also look at your total debt payments, including your potential home loan payment. If your total debt payments are more than 41% of your income, you need to have compensating factors like savings or a credit score of 680 or higher.
USDA Pros and Cons
What are the advantages and disadvantages of a USDA loan? Let’s take a look.
- No down payment. It’s hard to understate how big a savings this is. Other types of home loans require a down payment of 3% or more (usually more), which adds up to thousands of dollars. No down payment allows you to put that money toward other expenses, like moving, furnishing your home or maintaining an emergency fund.
- No mortgage insurance. If you make a down payment of less than 20% on a conventional loan, you need to pay for mortgage insurance. This insurance protects the lender if the borrower stops making mortgage payments. USDA loans don’t have mortgage insurance. There is a fee for the loan to pay for the USDA loan program, but that can be rolled into the cost of the loan.
- Can be used to build a home. You can use a USDA loan to buy and prepare a lot and build a home from the ground up.
- You can refinance. USDA loans have a streamlined refinancing option, which means you don’t have to get an appraisal, and you can adjust your loan term as needed.
- Income limits. If you make more than the income limit, you can’t take out a USDA loan. The income limits are in place because the program is designed to help low- and moderate-income households purchase a home.
- Location limits. You have to purchase a home in a designated area. If you’re attached to city life, a USDA loan might not be for you.
- Primary residence. If you’re looking for a 2nd home in the country, a USDA loan won’t work. You must use the loan for a primary residence.
The Best USDA Mortgage Lenders
As with any home loan, it’s best to get quotes from multiple lenders so you can compare mortgage rates. Here are Benzinga’s picks for the best USDA lenders. Remember, your real estate agent can only make so many recommendations for government-backed mortgages. Do your research, save for the down payment, look into adjustable rates and fixed-rate loans and search for the home of your dreams.
What is a Conventional Mortgage?
A conventional mortgage is a mortgage that’s not part of a government program. That means these loans aren’t directly insured by a federal agency. This gives lenders a lot of latitude when it comes to who can qualify for the loan.
Conventional loans come in 2 varieties: conforming and non-conforming. Remember, there are other types of loans like investment portfolio or jumbo loans. But, at the end of the day, they are either conforming or non-conforming loan types.
Conforming loans meet the requirements of Freddie Mac and Fannie Mae. These 2 private companies were started by the federal government and follow rules set by the government. They’re known as government-backed loan enterprises.
Fannie Mae and Freddie Mac help to stabilize the mortgage market. They promise to buy loans that meet specific requirements. This encourages lenders to make more loans since there’s not as much risk for them.
Non-conforming loans don’t meet the requirements of these companies. Lenders have a lot more flexibility when it comes to how these loans are structured, including origination fees, titling, closing costs and more.
Conventional Loan Requirements
What are the requirements for a conventional loan? They vary by lender and by whether it’s a conforming or non-conforming loan. Even so, the application process tends to be the same.
Conforming Loan Requirements
- Loan limits. Conforming loans have limits. The Federal Housing Finance Agency (FHFA) sets these limits each year. In 2020, the maximum for many areas of the country is $510,400 for a 1-unit property.
Some areas of the country have higher home prices, so they also have higher loan limits. The highest a home loan can be in a high-cost area is $765,600. You can see a map with loan limits on the FHFA website.
- Credit score. You need a credit score of 620 or higher to qualify for a conforming loan.
- Debt-to-income (DTI) ratio. Your DTI ratio is your gross (pre-tax) income compared to your monthly debt payments, including your potential mortgage payment.
If you make $4,000 per month before taxes and your home, car, credit card and student loan payments add up to $1,700 per month, you have a DTI ratio of 42.5%. You could qualify for a conforming loan with this DTI, as Freddie Mac and Fannie Mae require a DTI of 50% or less.
- Down payment. You must make a down payment with a conforming loan. Exactly how much varies. If you’re a first-time home buyer, you may be able to make a down payment of 3%. If you’re not, you may be able to make a down payment of 5% or more.
Non-Conforming Loan Requirements
Non-conforming loans aren’t standardized and don’t have set requirements. Lenders set the requirements for these mortgages. Some may be easier to qualify for than conforming loans, while others may have more stringent requirements.
Because these loans aren’t standardized, it’s important to review the terms of these loans carefully to make sure you understand the terms.
Conventional Pros and Cons
Is a conventional loan right for you? Let’s look at the benefits and drawbacks.
- Can be used for 2nd homes and investment properties. Conventional mortgages can be used for a wide range of properties. You don’t have to live in the property full-time, so it’s a good choice for a vacation home or for a home you plan to rent out.
- Can be used anywhere. Unlike a USDA loan, there are no limitations when it comes to where you can buy a home with a conventional mortgage.
- No income limitations. There’s no cap on the amount of income you can earn and qualify for a conventional loan. Lenders want to ensure you make enough to cover the cost of the loan, but there’s no maximum income limit as with a USDA loan.
- Private mortgage insurance (PMI). As mentioned previously, if you make a down payment of less than 20%, you will need to pay for PMI. This insurance is different from homeowners insurance, which you’ll also need. PMI protects the lender if the borrower stops paying on a mortgage. You can ask your lender to cancel PMI once your loan balance is less than 80% of the home’s value.
- Down payments. The amount of your down payment varies depending on the lender and whether it’s a conforming loan. Either way, you need to plan on a down payment.
The Best Conventional Mortgage Lenders
Take the time to compare conventional mortgage lenders so you find the best rate. Here are Benzinga’s top picks.
Choose a Lender
Choosing the right lender is a challenge. It’s important to take your time and check out a few options. A good lender will help you determine which mortgage option is the best for you, whether it’s a USDA loan, a conventional mortgage or something else.
Keep in mind the lender’s service options. Does it offer an online mortgage process? Can you connect your bank accounts and upload documents? Can you talk to someone easily if you have questions? Customer service is an important part of choosing a lender.
When you compare mortgage rates, look at more than just the interest rate. Keep in mind any fees or discounts, which can increase or decrease your costs. Look at how long the mortgage will last and whether the interest rate will stay the same. With some loans, the lender can change the rate down the road, which means your monthly payments can change too.
Start with our recommended lenders to find the right mortgage today, irrespective of the type of loan that you thought you needed. Prepare for the closing costs involved, primary mortgage insurance, property taxes and more. You can get into the house you want most, and there might be more loan options than you thought.
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