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 December 24, 2004 Residential Loans 
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Home Finance Basics

Understanding Home Finance

Whether this is your first home purchase or one of many, you're likely to have questions about the loan process.

At Coast Bank, we're committed to helping you understand home financing. So you can rest easy about your financing decision and enjoy the satisfaction of owning your home.

As a start, we recommend you review the following "Frequently Asked Questions." It answers the questions we hear most often about home loans, so it's a good place to begin.

What is a mortgage?

A mortgage is a loan borrowed to finance a home. It requires you to guarantee your home as the lender's security for repayment of your loan. The lender will hold the title to your home until you have paid back your loan plus interest. If you do not repay your mortgage loan, the lender has the right to take possession of your house and sell it in order to satisfy the debt.

Principal and Interest

Mortgage principal is the actual amount of money you borrow. So, if you take out a $80,000 mortgage, your mortgage principal is $80,000. Mortgage interest is the money you pay for use of the money you borrow. How much interest you pay over the life of the loan depends on a number of factors, like the size of your loan and the repayment term of the loan you choose.

How much can I borrow for my home?

The amount you may be able to borrow will depend on your income and current debts as well as the value of the home you're purchasing, the amount of your down payment and the current mortgage rates.

Generally, your monthly mortgage payment for principal, interest, taxes and insurance should not exceed 28 percent of your monthly pre-tax income. Monthly payments on other debts, such as car loans, school loans or credit card payments should not exceed an additional 5 to 8 percent of your monthly income. These percentages can be higher or lower depending on the type of loan you apply for, but they're a good place to start estimating.

Loans obtained during times of high interest rates will have higher monthly payments. Consequently, the lower the interest rate at the time you get your mortgage, the lower your monthly payments and the more you may be eligible to borrow.

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How to Buy Your First Home

Buying a first home is an exciting step. But for too many people, a first home seems like an unreachable dream. That's why we offer options that make getting started as a homeowner a little easier.

Low Down Payments and Closing Costs are Possible

The biggest challenge for most people is saving the money for the down payment and closing costs. While a larger down payment may make more options available to you, with many of today's loan programs, you may be able to buy a home with minimal down payment.

In addition, some programs will allow the seller or another person to contribute to the closing costs for you. Other programs allow all or a portion of the closing costs to be added to the loan amount, so you'll have less out-of-pocket expense.

Easier Approvals than Before

Another challenge for first-time buyers is the loan qualification based on current income and debts. Lenders evaluate the percentage of your income that will be used for your housing payment and other debts to make sure that you can handle the payments.

Today, however, lenders have learned that most homeowners are willing and able to put more into their homes than the traditional qualification standards allow. Several programs allow you to qualify for a larger mortgage compared to traditional loan programs.

Start Out Assuming You Can Buy a Home

A loan officer can show you which programs may fit the budget you have available.

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Fixed Rate vs. Adjustable

One of the most important decisions you face in the loan process-and often the hardest-is whether to take out a fixed or adjustable rate mortgage.

What's the difference between the two? In general terms, a fixed rate mortgage locks in at whatever prevailing interest rate is in effect at the time you arrange the loan. So no matter what happens to interest rates or inflation, your monthly principal and interest payment stays the same throughout the life of your loan. That stability is one reason why fixed rate mortgages are the most popular way to finance a home in America.

The mortgage payment for an adjustable rate mortgage, on the other hand, can change over time, since it continually "adjusts" to changing interest rates. That is good for lenders, because the rate keeps up with the prevailing rate. As a result, adjustable rate mortgages typically start at a lower interest rate than fixed mortgages do, and so your monthly principal and interest payment will be lower.

So, if the rate is lower, shouldn't you just choose an adjustable rate? The answer is: it depends. Anyone taking out an adjustable rate mortgage should be able to answer yes to the following questions:

  • Can I afford to make higher mortgage payments if rates go up?
  • Do I believe that rates will remain the same or decline in the future?
  • Do I plan on moving before 5-7 years?

The trade-off for the lower payments of adjustable rate mortgages is greater uncertainty in the amount of the payment. Deciding if the risks are worth it is a personal decision for every homeowner. Sometimes knowing your interest rate and monthly payment will not change can be an added peace of mind.

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15-year vs. 30-year Mortgage

Fifteen-year loans generally carry a lower interest rate than 30-year mortgages. They let you build equity faster, and they also lower the amount of interest paid over the loan term. Look at this comparison for the same loan amount. For illustration, the loan amount assumes that a 20% down payment has been made:
 30-Yr. Fixed 15-Yr. Fixed
Loan Amount$100,000$100,000
3 Points Paid$3,000$3,000
Interest Rate7%6.625%
APR7.5%7.125%
Monthly Payments*$665.00$899.00
Number of Payments360180
Total paid$239,400.00$161,820.00
Savings with 15 Year $77,580.00

*Payments shown are for principal and interest only; taxes and insurance are additional expenses. Fees and charges may apply. Rate is for example purposes only and is subject to change without prior notice.

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Mortgage Insurance

Lenders usually require mortgage insurance if a borrower puts down less than 20 percent on a home. This covers the lender against possible loss should the borrower default on their mortgage payments. The cost of mortgage insurance, or MI is normally reflected in a higher monthly payment and possibly an additional fee at settlement.

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