Today’s first-time homebuyers face a new set of homebuying hurdles. From saving for a down payment and closing costs to credit scores and debt, mortgage affordability is a key concern for many homebuyers. So today we’re reviewing pros and cons and costs and eligibility requirements associated with two affordable mortgage options: the USDA Rural Development and FHA loan.
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The Down Payment Scenario
Though they’re available to repeat homebuyers, FHA loans are often referred to as the “first-time homebuyer loan” because of their low down payment requirement. An FHA loan’s 3.5 percent down payment requirement can come from the borrower’s own funds, can be gifted by a family member or come from a grant from a state or local government down payment assistance program.
Arguably the biggest benefit of a USDA Rural Development loan is 100 percent financing, which means no down payment!
The Mortgage Insurance Premium Scenario
In January 2015, the FHA annual mortgage insurance premiums were reduced for the first time since 2001, making the affordable mortgage option even more affordable. The annual fee, which is paid monthly, is 0.85 percent (reduced from 1.35 percent) on 30-year fixed rate mortgages of $625,000 or less.
The FHA mortgage also carries an upfront fee, which is a one-time premium of 1.75 percent of the home loan. Borrowers can finance this charge into their loan.
In October 2016, the USDA also lowered fees on both annual and upfront mortgage insurance premiums. The upfront fee was lowered from 2.75 percent to 1.00 percent and the annual fee, which is paid monthly, also fell from 0.50 percent to 0.35 percent. The upfront fee alone would save a homebuyer purchasing a $175,000 home over $3,000. Borrowers can also finance this charge into their mortgage.
The Credit Score Requirement Scenario
Currently, Compass Mortgage has the ability to finance FHA loans to eligible borrowers with credit scores as lows as 560 (with a higher down payment requirement). As of December 1, 2014, the USDA set a credit score minimum of 640.
When it comes to loan approval, no credit is not good credit. This is why both FHA and USDA loans allow lenders to build credit history for borrowers through non-traditional tradelines, such as utility payment records, rent, cell phone payments, etc.
The Mortgage Rate Scenario
With conventional financing, credit score and down payment affect the interest rate a borrower receives. If a borrower qualifies for an FHA loan, they receive the current standard interest rate, which is very competitive and often lower than the rates of conventional loans.
USDA loans are insured by the U.S. Department of Agriculture, which gives borrowers the benefit of a low, across-the-board interest rate that does not vary based on credit score or down payment.
The Area Eligibility Scenario
USDA Rural Development loans are subject to area eligibility. Although you don’t have to live in a “rural” area, you must live in a small town – typically somewhere with a population less than 20,000 – to be eligible for a USDA loan. To see if your area is eligible for USDA financing, click here.
The Income Scenario
The USDA sets maximimum income limits for its borrowers. The maximum is set at 115 percent of the median area or county income. You can see the income limits for your area by clicking here. For those who don't fall within the USDA's income limits, FHA loans come with no maximum income limits.
Overall, both the FHA and USDA Rural Development loan programs are great options for first-time homebuyers who either have limited means for a down payment and low credit or limited credit history. To learn more about your loan options as a first-time homebuyer, download our free Mortgage 101 Handbook.