Depending on where you live, you might qualify for a USDA loan. For those looking to buy a home, this begs the question: should you pursue this option instead of a conventional loan?
We’ll explain the differences between conventional and USDA mortgage loans, their requirements and the pros and cons, so you can make the choice that’s best for your situation.
Defining USDA and Conventional Loans
Most Americans don’t have the cash to buy a home outright. In fact, over 90% of home purchases use mortgage financing.[1]
Both USDA loans and conventional loans are types of mortgages. Generally, a lender provides the money to purchase the home, and then the borrower repays the loan to the lender, plus interest.
But while both are mortgages, a USDA loan is not the same as a conventional loan.
USDA loans: These are mortgage loans insured by the U.S. government – specifically, the U.S. Department of Agriculture (USDA). They offer unique benefits, such as no required down payment, but come with strict eligibility requirements.
Conventional loans: These mortgage loans aren’t backed by a U.S. federal agency. There are two categories of conventional loans: conforming and nonconforming.
These loans meet the specific standards set by Fannie Mae and Freddie Mac. (Nonconforming loans do not.) Conforming loans are the most common loan type [2] and are seen as being less risky.
USDA vs. Conventional Loan Eligibility Requirements
This table gives a quick overview of the different requirements for each type of loan.
| Category | USDA Loan | Conventional Loan |
| Property Location | Must be in an eligible rural area | No requirement |
| Income | Maximum limit: income can’t exceed 115% of median local income.[3] | No maximum limit, but you must prove “stable and predictable income.”[4] |
| Credit Score | 640 and above: streamlined approval 640 and below: Possible approved, but USDA will analyze credit history[5] |
Minimum 620 for fixed-rate mortgage[6] |
| Debt-to-Income Ratio | Proposed monthly housing expense shouldn’t exceed 29% of repayment income. Total debts shouldn’t exceed 41% of repayment income.[7] |
Maximum DTI ratio is 36% of the borrower’s stable monthly income. DTI ratios up to 50% may be approved, if the borrower meets certain requirements and is underwritten through DU.[8] |
| Down Payment | No requirement | Minimum 5% (unless you meet specific requirements) |
Location
One of the USDA’s main functions is to ensure the vitality of America’s rural communities. To qualify for a USDA mortgage, the property must be located in an eligible rural area as defined by the USDA.
Conventional loans don’t have these restrictions on location, but you’ll need to meet other eligibility requirements.
Income
USDA loans have adjusted income limits, which vary based on where the property is located and how many members live in the home.
For example, in Henry County, Alabama, the moderate income limit is $103,500 for households of up to 4 people, but this increases to $136,600 for houses of 5 – 8 people. These limits differ from county to county and state to state.[3]
For conventional loans, there’s no maximum income limit. The key is to provide proof of stable income via documentation. This shows the lender that the borrower will be able to make their monthly mortgage payments.
Credit score
Your credit score can have a big impact on whether you qualify for a given mortgage.
The critical credit score for USDA loans is 640.[5] If your credit score is 640 or above, you’ll enter what’s known as “streamlined” credit approval and avoid manual underwriting. Because the process is more automated, it usually moves faster.
If your credit score is under 640, you can still be approved, but your credit history will be analyzed by the USDA. They may ask you to provide alternative credit sources. This can come from creditors who don’t report to the credit bureaus or third-party sources.
Even if your score is under 640, and you can’t provide alternative proof of credit, you still might qualify for an exception to credit standards. Here are some exceptions the USDA may consider:[5]
- Reduced shelter costs
- Temporary situation
- Benefit to the government
The process is more defined for conventional loans. With very few exceptions, you need a minimum credit score of 620 to qualify for a conventional mortgage.[6]
Debt-to-income ratio
The most straightforward way to qualify for a USDA loan is to keep your proposed monthly housing expenses below 29% of your estimated repayment income and your total debt-to-income (DTI) ratio below 41% of your repayment income.[7]
That said, the USDA still has the ability to grant the loan – even if the borrower’s ratios exceed these limits – if the lender determines there are strong compensating factors indicating a household has a higher repayment ability.
For a conventional loan, you should aim for a DTI ratio of under 36%. Although, you can still be approved with a ratio of up to 50% if your case file goes through DU underwriting.[8]
This is an automated underwriting tool created by Fannie Mae. It provides credit risk assessment for applications and delivers recommendations based on the documentation submitted.
Down payment
One of the biggest selling points of a USDA loan is there’s no down payment requirement. This can allow borrowers to start building equity without spending years saving for a down payment.
For a conventional loan, you’ll need a minimum of 5% down. You can get approved for as little as 3% down if you meet specific requirements related to income and if you are a first-time home buyer.
5% down for a $350,000 property would come to $17,500. However, if you put down less than 20%, you’ll likely have to pay private mortgage insurance (PMI). This will be added to your monthly mortgage payment.
Which Loan Is Better?
To help you understand why each loan option might work for your situation, we’ve compiled some benefits and drawbacks.
USDA loan pros and cons
✅No down payment
Borrowers with a USDA loan aren’t required to make a down payment. This is one of the biggest perks of the program.
✅Competitive interest rates
USDA loans are backed by the government, which allows lenders to offer competitive interest rates that are often lower than those for conventional loans.
⛔More restrictions
To qualify for a USDA loan, you must live in a defined rural area and plan to use the property as a primary residence. There are also maximum income limits.
⛔Guarantee fees
Instead of PMI, borrowers will pay a guarantee fee. This fee consists of an “upfront” payment (1% of the loan value) and then an “annual” fee (0.35% of your loan balance) [9] which you’ll pay each month as a part of your mortgage payment.
⛔Longer approval process
Because the loan needs to be approved by both the lender and the USDA, the process usually takes longer than it would for a lender to approve a conventional loan.
Conventional loan pros and cons
✅Fewer restrictions
You don’t need to live in a rural area to apply for a conventional loan. You can buy a home anywhere. Additionally, you won’t be ineligible for a loan because your income is too high.
✅Flexible terms
Borrowers can choose the length of a fixed conventional loan from 8 to 30 years.
✅Can be used for different property types
Conventional loans aren’t limited to primary residences. They can also be used for second homes, vacation houses and investment properties.
⛔Down payment
You’ll need to put at least 5% down to qualify for a conventional loan in most cases.
⛔PMI requirement
If you put less than 20% down, PMI will be added to your monthly mortgage payment. It will stop automatically once 22% of the purchase price has been paid.[10]
Tips for Choosing Between USDA and Conventional Loans
It’s one thing to have a general understanding of how these loans work. It’s another to apply this knowledge to your own financial situation. To help you get started, here are some questions to ask yourself:
- Which of these loans do I qualify for? Zero money down might sound enticing. But if you don’t live in a rural area or if you make too much money, you won’t qualify for a USDA loan.
- How much can I afford to put down? With a USDA loan, you’ll pay the guarantee fees no matter how much you put down. With a conventional loan, you won’t pay PMI if you can put 20% down.
Is it better to use a USDA loan or a conventional loan?
It depends on your financial situation and what you qualify for. Assuming you can qualify for a USDA loan, the zero down payment can make homeownership a reality faster. That said, if you can save for a down payment, you’ll owe less interest over the life of the loan. Plus, PMI will fall off your mortgage once you’ve repaid 22% of the home’s value. With a USDA loan, you’ll owe the annual portion of the guarantee fee for the life of the loan.
Are USDA rates lower than conventional?
Generally, because USDA loans are secured by the government, lenders can offer them with competitive rates. While these rates can be lower than those offered for conventional loans, it’s a good idea to check current rates.
How can I tell if I’m eligible for a USDA loan?
The first step is to check if you live in an eligible rural area. From the USDA website, you can also contact a program representative who can answer your questions and walk you through the application process.
Two Loans Diverged in a Wood
When it comes to choosing between these loans, your circumstances should guide your choice. If you have money saved for a down payment and don’t want any restrictions on where you can live, a conventional loan is probably the better option.
That said, if you’re looking at property in a qualified rural area and make a low to moderate income, the USDA program exists to help make homeownership a reality.
Home is worth it.
The mortgage process can be exciting, and we’ll be with you all the way. Take the first step to owning a home. You’ll be glad you did.
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U.S. Census Bureau. “New Houses Sold by Sales Price: United States.” Retrieved January 2023 from https://www.census.gov/construction/nrs/pdf/quarterly_sales.pdf
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Consumer Financial Protection Bureau. “Conventional Loans.” Retrieved January 2023 from https://www.consumerfinance.gov/owning-a-home/loan-options/conventional-loans/
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United States Department of Agriculture. “Rural Development Single Family Housing Guaranteed Loan Program.” Retrieved January 2023 from https://www.rd.usda.gov/sites/default/files/rd-grhlimitmap.pdf
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Fannie Mae. “Selling Guide.” Retrieved January 2023 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-3-Income-Assessment/Section-B3-3-1-Employment-and-Other-Sources-of-Income/1032992031/B3-3-1-01-General-Income-Information-10-05-2022.htm
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United States Department of Agriculture. “Section 502 Direct Loan Program’s Credit Requirements.” Retrieved January 2023 from https://www.rd.usda.gov/files/RD-SFH-CreditRequirements.pdf
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Fannie Mae. “Selling Guide.” Retrieved January 2023 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/Section-B3-5-1-Credit-Scores/1032996841/B3-5-1-01-General-Requirements-for-Credit-Scores-08-05-2020.htm
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United States Department of Agriculture. “Chapter 11: Ratio Analysis.” Retrieved January 2023 from https://www.rd.usda.gov/files/3555-1chapter11.pdf
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Fannie Mae. “Selling Guide.” Retrieved January 2023 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-6-Liability-Assessment/1032992131/B3-6-02-Debt-to-Income-Ratios-02-05-2020.htm
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United States Department of Agriculture. “Regulations and Guidelines.” Retrieved January 2023 from https://www.rd.usda.gov/publications/regulations-guidelines/instructions
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Federal Reserve. “Compliance Handbook, Homeowners Protection Act.”Retrieved January 2023 from https://www.federalreserve.gov/boarddocs/supmanual/cch/hpa.pdf