If you put less than 20% down on a conventional loan, you pay for Private Mortgage Insurance. The PMI protects the lender should you default on your loan. It makes sense that USDA loans would have mortgage insurance too, right? After all, you can borrow 100% of the home’s value. The USDA doesn’t charge Private Mortgage Insurance, though. Instead, they charge an annual fee.
Keep reading to learn the difference.
Conventional Loan PMI
Private Mortgage Insurance on conventional loans costs between 0.5% to 1% of the loan amount. The amount you pay depends on your credit score and down payment. The lower your credit score and down payment, the more PMI you’ll pay. The amount you pay is based on your ‘riskiness.’ A low credit score means you have a higher risk of defaulting on the loan. Making a lower down payment also puts you at risk of default. The more ‘skin in the game’ that you have, the less likely you are to default.
The USDA Annual Fee
The USDA charges what’s called an annual fee. Right now, the annual fee is 0.35% of the loan amount. While the amount is calculated annually, you pay it off monthly. For example, if you borrow $150,000, you’d owe $525 per year or $43.75 per month. You pay the monthly fee with your mortgage payment every month.
How Long Does PMI and the USDA Annual Fee Last?
In addition to the percentage difference, PMI and the USDA annual fee have differing terms too. You pay PMI only if you borrow more than 80% of the home’s value. You continue to pay it as long as you owe more than 80% of the home’s original value. Once you pay the principal balance down enough to have at least 20% equity in the home, you can request that the lender cancel the PMI. In fact, by law, the lender must automatically cancel the insurance once you owe less than 78% of the home’s original value.
The USDA annual fee lasts for the life of the loan. There isn’t an option to cancel it. As long as you have an outstanding mortgage balance, you pay the annual fee for that balance. The amount you pay may decrease slightly every year, as you pay the principal balance down, but you’ll never have a USDA mortgage payment without the annual fee payment.
The Other USDA Fee
You’ll also pay an upfront guarantee fee on a USDA loan. The USDA uses these funds to continue guaranteeing loans for borrowers. Since the USDA is self-funded, they rely on the payments. With the guarantee from the USDA, lenders are able to give loans to borrowers that would otherwise be ineligible to get a loan. The USDA loan is often the ‘last resort’ loan.
Right now, the USDA fee is 1% of the loan amount. On the $150,000 loan, you’d owe $1,500 at the closing. If you can’t afford to pay it at the closing, you can wrap the fee into your loan. You can do this even if you borrow 100% of the sales price.
Qualifying for a USDA Loan
Qualifying for a USDA loan is a little more flexible than a conventional loan too. Conventional loans typically require higher credit scores and lower debt ratios. That’s how conventional lenders get away with canceling your PMI once you owe less than 80% of the home’s value. USDA loans require:
- 640 credit score
- 29% housing ratio
- 41% total debt ratio
- Stable income and employment for the last 2 years
- No defaulted federal payments
- Proof that you’ll occupy the home as your primary residence
You must be eligible for the USDA loan program too. This means:
- Your household income doesn’t exceed the limits for your area
- You don’t qualify for any other type of financing including conventional and FHA loans
- You will buy a home in a rural area as designated by the USDA
The USDA annual fee is similar to PMI, but only in that it helps the USDA guarantee the loan for lenders. PMI can be more expensive, but can be canceled. The two loans are mutually exclusive, though. If you qualify for a conventional loan, you won’t qualify for a USDA loan.