Most people interested in buying a home have come across the mention of FHA loans, but they may not be sure what they are, how they work, or if they are eligible.

What is an FHA Loan?

FHA loans come from private lenders but are insured by the Federal Housing Administration (FHA). In case of borrower default, the FHA will pay the remaining balance. This guarantee minimizes a lender's risk in issuing a loan and allows it to give lower interest rates on mortgage loans. FHA loans may be either fixed rate (interest rates never change) or adjustable rate mortgages (ARMs), where rates vary over the life of the loan. The FHA also offers special refinancing and cash-out programs.

History of FHA Mortgages

The Federal Housing Administration was created in 1934 during the Depression. At this time in history foreclosures were high, and according to U.S. Department of Housing and Urban Development statistics, only 40% of Americans owned homes. The aim of FHA mortgage insurance was to increase the number of American homeowners by helping more people qualify for mortgage loans.

In recent decades, private mortgage insurance (PMI) has become a lot more common. Now, people who generally seek out FHA loans are first-time homebuyers who can't afford a large down payment or people who have trouble qualifying for PMI.

Benefits of FHA Mortgage Loans

Insurance from the FHA allows many people to qualify for mortgage loans and buy homes when they wouldn't have been able to do so otherwise. Benefits of an FHA mortgage include:

• more lenient eligibility criteria than conventional loans
• 3.5% down payment (compared to the typical 10% down payment required under a conventional loan)
• 2% to 3% closing costs that may be built into the mortgage amount
• lower interest rates than conventional loans
• detailed FHA home appraisal

Eligibility for FHA Loans

Not everyone will qualify for FHA loans, however. The applications for mortgage loans available on the FHA's website are the only surefire way to know whether you qualify. But in general, applicants must:

• be primary residents of the home
• be able to afford a 3.5% down payment
• pay a 2% to 3% closing cost (which could be absorbed into the mortgage)
• pay no more than 27% of their gross monthly income in monthly mortgage payments including principal, interest, taxes, and insurance
• have a satisfactory credit history, even if there have been past problems
• have established employment and a good employment history

Contrary to popular belief, there is no income limit on who can obtain an FHA loan. Remember that the purpose of the FHA is to help people obtain a primary home, so if applicants do not plan to live at a residence full-time then FHA loans won't be a good option.

How to Get an FHA Loan

After applying for FHA mortgage loan insurance, applicants should contact lenders and ask if they originate FHA loans. The FHA doesn't issue loans or set interest rates, it just guarantees against default. So it's important to shop around and compare mortgages from several different lenders for the best interest rate and loan terms.

FHA loans are government-insured mortgages designed to help more people become homeowners. Whether a conventional loan or an FHA loan is best depends on each person's individual finances and circumstances, so it's best to weigh all options carefully and seek the guidance of a professional financial advisor when applying for a mortgage loan.