The Federal Housing Administration (FHA) was established around the time of the Great Depression to help Americans buy homes. Today, the FHA continues to insure loans by offering low down payments and refinancing options with attractively high loan-to-value ratios.

Less than half of Americans could afford a home when the FHA loan program was first launched back in the 1930s. Since that time, the agency has made loans possible for about 40 million homeowners. The agency doesn't actually make loans, but instead, provides mortgage insurance to reassure lenders that their losses will be covered if a borrower defaults.

Because the insurance provides a financial safety net, banks and mortgage companies agree to provide loans with much lower down payments, and to refinance homes with higher than normal loan-to-value ratios. When you buy a home with an FHA-insured loan, for example, you can get loan approval with a down payment as low as three percent. If you need to refinance to get access to your equity in the form of spendable cash, most lenders in today's market will lend you 70 percent of what your home is worth. But with FHA refinancing, you can get as much as 95 percent.

How FHA insurance works

Homeowners pay for the FHA insurance through a combination of private mortgage insurance (PMI), and additional fees that are paid as an up-front insurance payment when the loan is originated. But like other PMI programs, FHA mortgage insurance premiums can be dropped from your monthly payments as soon as your mortgage balance falls to a level of 75 percent of the original loan amount of your home. To make it easier to finance a home, the FHA provides somewhat lenient payment terms and will often lend money to those with lower incomes, or less than perfect credit. The agency also offers guidance for those who need to improve their credit, and if you apply for one of its loans and fail to meet their credit requirements, it will refer you to a different kind of company-one that does authorized consumer credit counseling.

Double your pleasure

As part of the ongoing effort to stimulate the U.S. economy, the FHA was recently given the authority to raise the limits on its loans, with the upshot being that you can borrow nearly twice as much as before. By increasing the size of its loans, the FHA is in a better position to compete within today's higher-priced housing market as an affordable alternative for buying a home, or refinancing an existing mortgage.

An FHA-insured mortgage is usually a sensible option for someone who has less available cash. Those who can afford large down payments may find a more competitive deal through a conventional loan, like those backed by Fannie Mae or Freddie Mac. If you're thinking of buying or refinancing, have your mortgage broker or bank loan officer show you a side-by-side comparison between an FHA loan and other available mortgages.