Navigating the mortgage maze

Whether you’re buying your first home or your fifth home, your finance options can be confusing. That’s because many types of mortgage loans are available, with varying rates and terms. However, the basic difference in mortgage loans boils down to these differences:

• Whether the interest rate is fixed or adjustable.
• Whether the loan is government insured.

Fixed or adjustable?

As the name implies, a fixed-rate loan is a mortgage loan with an interest rate that never changes. Since the interest rate never changes, the monthly payment amount never changes, either. That means, for example, if you get a 30-year fixed rate loan and keep the loan for that long, you’ll make 360 identical payments to your lender (give or take a few dollars on the final payment).

Many consumers like the predictability and stability of a fixed rate mortgage. And over time, as your income presumably grows, that fixed payment amount will seem smaller and smaller. When rates are historically low, like they are now, fixed rate mortgages are a good deal.

If you’re looking for the lowest possible initial payment and you’re confident that your income will rise over time, you may want to consider an adjustable rate mortgage, or ARM. With an ARM, your initial rate is a) typically lower than the rate on a fixed rate loan, and b) locked in for five years. That means that your ARM will behave like a fixed rate loan for the first five years.

But what happens after five years?

Your rate will start adjusting – as often as annually and as infrequently as every five years, depending on the terms of your specific loan. It should come as no shock that ARM rates generally adjust up rather than down. And every time your rate goes up, your payment goes up, too. This can come as quite a shock to a fragile budget.

Rates are expected to increase over the next several years, so if you opt for an ARM, keep in mind you may experience some serious sticker shock in five years when your rate adjusts … and it will adjust higher.

Conventional or government insured?

A conventional loan is one that involves just you and your lender. Pretty simple, eh? So why would you want to get the government involved in your mortgage loan?

It depends on which government insured loan program we’re talking about. These loans come in three flavors: FHA, VA and USDA.

An FHA (Federal Housing Administration) loan can be a good choice if you don’t have much money to put down – it only requires a down payment of 3.5 percent, while most conventional loans require a down payment between 5 and 20 percent. An FHA loan can also be helpful if your credit is less than stellar. Since your loan is insured by the government, your lender may be willing to make what may seem like a riskier loan, because the government will guarantee the bank will be repaid, at least in part, if you can’t.

The rub? The FHA doesn’t insure these loans just to be nice. You actually have to pay for that mortgage insurance yourself, an amount that’s tacked to your monthly mortgage payment. However, if you get a conventional loan and have less than 20% for a down payment, many states require that you pay mortgage insurance, called PMI.

If you’re a veteran of any branch of the U.S. military, you should consider a VA loan. The VA loan program is administered by the Department of Veteran Affairs. A VA loan works a lot like an FHA loan, except for one extremely important difference: A VA loan doesn’t require any down payment whatsoever. That can be huge for a cash-strapped family looking to own their own home.

Finally, the U.S. Department of Agriculture offers a loan program for low-income families living in rural areas. To qualify for this program, your family can’t earn more than 115 percent of the average median income for your county.

The loan types described here cover the vast majority of U.S. mortgage loans, but there are many, many subtle variations. If you have questions, your best bet is to ask a mortgage expert at your credit union.