How do USDA Loans Differ from Conventional Loans?

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You probably hear more about conventional loans than you do USDA loans. They are the ‘traditional’ loans but they are conventional only because they aren’t back by a government agency.

USDA loans are backed by the USDA. If a USDA borrower defaults on a loan, the USDA pays the lender back a portion of the funds they lost. This gives lenders the ability to provide 100 percent financing without having strict requirements. In other words, it makes it easier for low to moderate income families to afford to buy a home.

Beyond the ‘backing’ USDA loans and conventional loans work in the same manner. You pay principal and interest on both loans each month, but USDA loans do charge mortgage insurance. That’s how the USDA is able to back the loans. The insurance funds help the USDA bail out lenders with defaulted loans.

I’ve covered the other major differences for you below so you can see how similar and attractive USDA loans in Colorado are for borrowers.

The Down Payment Difference

You know that USDA loans don’t require a down payment, but did you know conventional loans do? This is a major difference between the two programs. Conventional loan borrowers need a 3 percent down payment for first-time homebuyers and a 5 percent down payment for subsequent home buyers.

On a $200,000 loan, conventional loan borrowers need at least $6,000 - $10,000 down on the home. USDA borrowers don’t need anything.

Credit Score Differences

The USDA and conventional loans have similar credit score requirements. USDA borrowers need a 640 credit score or higher. Most conventional loan lenders require a 660 or higher, so a slightly higher credit score, but not by much. The credit score is what lenders use to make sure you are a suitable borrower and will make your mortgage payments.

Debt Ratio Differences

The USDA is more lenient with their debt ratio guidelines. They allow borrowers to have a housing ratio of up to 31 percent. This means your total housing payment including the principal, interest, real estate taxes, homeowners insurance, and mortgage insurance may take up 31 percent of your gross monthly income. Conventional loans require a 28 percent or lower housing ratio.

The USDA also allows up to a 41 percent total debt ratio. This takes into account your ‘other’ debts, such as credit cards, car loans, and student loan payments plus the new mortgage. Conventional lenders require a maximum 36 percent total debt ratio, which means it’s harder to qualify for.

Mortgage Insurance Differences

You may pay mortgage insurance on a conventional loan, but you’ll definitely pay it on a USDA loan.

Conventional loans only require it if you borrow more than 80 percent of the home’s value. If you do, you’ll pay Private Mortgage Insurance until you owe less than 80 percent of the home’s value. This means if you make a large down payment, you won’t pay the mortgage insurance for long, if at all.

USDA loans require mortgage insurance for the life of the loan. Granted, the amount is much less than what you’d pay on a conventional loan, but it lasts for the entire 30 year loan term. The USDA charges 0.35 percent of your outstanding loan balance, but they break the payment down monthly to make it more affordable. You can’t cancel USDA mortgage insurance, even when you owe less than 80 percent of the home’s value.

Appraisal Differences

Both USDA and conventional loans require a home appraisal. Lenders need to know the home is at least worth as much as the purchase price. Both appraisals ensure the home is in good condition, but the USDA loan takes it a step further.

The USDA appraisal ensures the home meets the USDA minimum property guidelines. They look for basic things like year-round street access to the home, working utilities, and a stable roof and heating system. The USDA appraisal ensures the home is in decent condition for low to moderate-income families.

If you qualify for a conventional loan, you won’t qualify for a USDA loan, but if you can’t get conventional or FHA financing, then you’re a good USDA loan candidate.

I’d be happy to walk you through the eligibility process to see which loan suits your needs the best. All loans are attractive, affordable, and will help you become the Colorado homeowner you want to be. Let’s chat soon to see how we can help you buy a home.

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