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How Smart a Home Buyer Are You?

Pat Mertz Esswein, Associate Editor, Kiplinger's Personal Finance

The more you know about the home-buying process, the more money, time and hassle you'll save -- no matter what the current real estate market is doing.

Here are 10 questions to see how prepared you are to buy a house. Take our quiz:

1: Which matters more: being prequalified for a mortgage or preapproved?

  1. A. Prequalified
  2. B. Preapproved

The correct answer is B. B. Preapproved

Make sure you're preapproved before you shop for a home. Prequalification is just an estimate of what the lender thinks you can afford. For a preapproval, lenders will not only pull your credit report, but they'll also require documentation to verify your income and financial history. The preapproval letter assures you and prospective sellers and their agents that you can obtain a mortgage. Without it, they may not consider your offer. A preapproval is usually good for 60 to 90 days.

2: You must be prepared to make a down payment of 20% of the purchase price of any home you seek to buy.

  1. A. True
  2. B. False

The correct answer is B. B. False

Most lenders offer mortgage programs that allow low- to moderate-income borrowers to make much smaller down payments.

With the Home Possible program, backed by Freddie Mac, you can qualify for a mortgage with as little as 3% down. You needn't be a first-time home buyer, but your income may not exceed 100% of your area's median income (there's an exception for low-income neighborhoods). The source of funds for the down payment can include a gift from a family member. Fannie Mae offers a similar 3% down program, called Home Ready.

The Federal Housing Administration (FHA) has traditionally served mortgage borrowers with less-than-stellar credit. Its loan program requires a minimum of 3.5% down.

3: How much should you expect to pay for closing costs?

  1. A. 1% of the purchase price
  2. B. 3% to 6% of the purchase price
  3. C. 10% of the purchase price

The correct answer is B. B. 3% to 6% of the purchase price

In addition to a down payment, buyers should budget an extra 3% to 6% of the purchase price to cover costs at settlement. These usually include the loan origination fee, any discount "points" you pay to get a lower mortgage interest rate, the cost of title insurance, government recording charges, transfer taxes, an initial deposit for an escrow account (for, say, property taxes and hazard insurance), and services, such as a home inspection, that you or the lender pay for.

4: The title insurance you're required to buy in order to get your loan is for your own protection.

  1. A. True
  2. B. False

The correct answer is B. B. False

You're required to pay for lender's title insurance at settlement, but it's not for your benefit. It only shields the lender in case a problem with the property's title arises (such as unclear wills, unpaid taxes and easements).

5: If you draw any money from your Roth IRA to buy your first home, you have to pay it back before retirement.

  1. A. True
  2. B. False

The correct answer is B. B. False

Nothing has to be repaid, ever. You can tap all your contributions (not earnings) to your Roth for any purpose, including a down payment on a home, at any time, tax and penalty free. And, after the account has been opened for five years, you also can withdraw up to $10,000 of earnings tax- and penalty-free for the purchase of your first home ($20,000 if you're married and you each have a Roth). Assume $5,000 goes into a Roth each year for five years, and the account earns an average of 8% a year. At the end of five years, the Roth would hold about $31,680 -- all of which could be withdrawn tax- and penalty-free for a down payment.

6: Adjustable-rate mortgages can still be a good deal for some people, even when rates are rising.

  1. A. True
  2. B. False

The correct answer is A. A. True

True, but you must manage the risk of a rising interest rate. Start by choosing an ARM with an initial fixed-rate period that matches how long you plan to own the house, say, 5 or 7 years. And, to protect against the possibility that you can't sell when you want or need to, make sure that you can afford the monthly payment if the rate rises to the limit of the cap on the first rate adjustment, typically 2 percentage points.

7: About how much will a home inspection typically cost you?

  1. A. $75 - $100
  2. B. $300 - $400
  3. C. $800 - $1,000

The correct answer is B. B. $300 - $400

Plan on paying between $300 and $400. That fee may vary by region and sometimes on the age, size and construction of the house. When you make an offer on a home, make it contingent on a satisfactory home inspection. In a market where buyers have some advantage over sellers, you can use the inspector's report for further price negotiations if the property needs any major repairs.

8: Who needs private mortgage insurance?

  1. A. Buyers with a down payment less than 20%
  2. B. Buyers with a down payment more than 20%
  3. C. It's optional for all buyers
  4. D. It's mandatory for all buyers

The correct answer is A. A. Buyers with a down payment less than 20%

If your down payment on a home is less than 20% of the appraised value, you will have to pay for private mortgage insurance. This protects the lender if you default on your loan. PMI costs about 0.5% to 1.5% of the amount of the loan per year. So, for a $200,000 mortgage, you'd pay about $1,000 annually, or $83.33 per month, at the lower rate.

With a loan backed by Fannie or Freddie, you can ask the lender to eliminate the cost of private mortgage insurance when your equity reaches 20% of the home's value (a loan-to-value ratio of 80%) through home-price appreciation and paying down the mortgage. The lender must automatically eliminate the mortgage insurance when you reach 22% equity (a loan-to-value ratio of 78%). With an FHA loan, you must pay for mortgage insurance for as long as you have the loan.

9: You find a condo you like. Your realtor tells you two other units in the building sold for $200,000 and $225,000. What should you offer?

  1. A. $185,000
  2. B. $200,000
  3. C. $212,500
  4. D. Hold on. You need more information.

The correct answer is D. D. Hold on. You need more information.

That's not enough info to make your decision. You should find out when those sales took place, what the properties were originally listed for and how long they were on the market. Plus, you'll want to know how the units compare in size, style, amenities and location in the building. Then consider the asking price for the unit you want and make allowances for the current market climate, whether it's a buyer's market or a seller's. (This shouldn't be an afterthought. It's part of determining whether those sales are truly comparable.)

10: As a new homeowner, what costs can you deduct from income when you file your federal taxes?

  1. A. Mortgage interest
  2. B. Property taxes
  3. C. Points paid at settlement
  4. D. Private mortgage insurance
  5. E. Everything except "D"

The correct answer is E. E. Everything except "D"

In the past you probably took the standard deduction when you filed your federal income taxes. But once you own a home, itemizing may make sense--and save you a lot on your tax bill. However, under the Tax Cuts and Jobs Act, the deductions aren't as generous as they once were.

In the past, you could deduct interest on a mortgage of as much as $1 million ($500,000 if you're married filing separately). Now, you can only deduct interest on as much as $750,000 ($375,000 if you're married filing separately). You can also still deduct interest on a second home, but total mortgage interest (for all homes) is capped at $750,000.

The new law also caps the amount of state and local property taxes you can deduct at $10,000 ($5,000 if married filing separately).

The deduction for mortgage insurance premiums expired at year-end 2017, and Congress hasn't renewed it.

In the year you buy a house, you can still write off discount points you may have paid when you took your mortgage, as well as deduct points that the seller paid for you!


Copyright 2016-2019 The Kiplinger Washington Editors