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Tight supply, tough rules can test home buyers

Mortgage rates are low, but qualifying for a loan is tougher since the financial crisis.

Associated Press/File 2013

Mortgage rates are low, but qualifying for a loan is tougher since the financial crisis.

After years in the doldrums, the housing market appears back on track. Home sales and prices are up, and mortgage rates remain near historic lows, reinvigorating the appeal of homeownership.

But qualifying for a home loan remains a hurdle for anyone without a solid personal balance sheet.

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‘‘Now the requirements are much stricter,’’ says Erin Baehr, a certified financial planner in Stroudsburg, Pa. ‘‘You have to have the right income, you have to have the right credit score, and you have to have the right down payment to get the best rates out there.’’

In addition, a tight supply of homes for sale in many markets means sellers often have the leverage that comes with receiving competing offers. That means buyers with the financial flexibility to raise their offer stand a better chance of winning out — another reason to bolster one’s finances before entering the fray. Here are six tips:

 Assess your finances and how much you can afford.

Before you get too involved in looking at listings, evaluate your finances thoroughly. If you’re a first-time buyer and haven’t been saving money or have been living paycheck-to-paycheck while dealing with college loans and other debt, you’ll probably have to make major lifestyle changes.

Ultimately, you want to get an idea of how much of your monthly income you can reasonably afford to spend on a home.

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Stew Larsen, head of Bank of the West’s mortgage banking division, offers the rough formula lenders use: Add up the monthly house payment — principal, interest, taxes, insurance — and subtract it from your gross monthly income. The house payment should not be more than 30 percent of the monthly income.

Bankrate Inc.’s online calculators can also help estimate how much you can afford.

 Budget as if you were already a homeowner.

You’ve figured out roughly how much money you should devote to housing. But can you live on that amount, especially when you consider other costs, such as for repairs and utilities, which often run higher than in apartments? And if you buy a condominium there will be association fees.

Baehr recommends that renters calculate the extra monthly costs that come with homeownership and start setting aside that amount. This accomplishes two things: saving money for a down payment and getting accustomed to the financial constraints of homeownership.

‘‘Start to put that money away and see if you can live without it,’’ Baehr says. ‘‘If you can’t do it now, you’re not going to be able to do it later.’’

 Shoot for 20 percent down.

While some loan programs allow allow a down payment of as little as 3.5 percent of the purchase price, experts say you’ll need to save enough for at least a 20 percent down payment in order to get the lowest interest rate and avoid paying for private mortgage insurance, or PMI.

Military veterans can qualify for a loan program that lets them get a mortgage without a down payment.

Even if you end up having to buy private mortgage insurance, once you have a 20 percent stake in the home you can apply to have PMI waived. Until then, PMI is tax-deductible.

You’ll also need money for closing costs, which can sometimes run into the thousands of dollars.

 Tackle any credit problems ­early.

A credit score is a critical element in how lenders determine how much money buyers can borrow and at what interest rate.

Baehr says buyers seeking the most favorable rate must generally have a FICO score of at least 720 out of 850. Loans backed by the Federal Housing Administration require a FICO score of at least 580, but you’ll pay a higher interest rate.

Check your credit reports for any errors that may be weighing down the credit score. Disputing errors can take months. Baehr recommends getting started six months in advance.

A major component of one’s credit score is the ratio of credit available to debt. You can improve your score by paying down debt over time.

Consumers are entitled to a free credit report every 12 months from each of the credit bureaus: Experian, TransUnion, and Equifax. You can get copies at www.annualcreditreport.com.

Avoid taking on debt in the months before you start shopping. New loans or credit cards can ding your credit score temporarily.

Even borrowers who use credit cards often but pay down the balance every month should refrain or ease off for a couple of months before seeking a home loan, Baehr says.

 Get financial documents in ­order.

Lenders will probe deep into your records. Get ahead of the requests by pulling together at least three months of bank statements and pay stubs and at least two years of income tax filings.

If you’re going to get help with the down payment, the bank will want to know the source. Your benefactor might also need to show bank statements.

 Get preapproved for a loan.

Before you begin your home search, ask a lender to assess how much you can borrow. A preapproval letter is a solid indication of what you can spend.

‘‘It’s not like having cash in hand, but it’s almost as close,’’ Larsen says.

One caveat: Understand the difference between a preapproval letter and being prequalified for a loan. Being prequalified doesn’t commit the lender. It’s basically an opinion drawn from a cursory assessment of your finances. A preapproval letter is preceded by a thorough credit and income review. The loan goes through after all the borrower’s information is verified.

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