The Four Pillars Of Tenant Screening

xanten-279944_1280-PDThere are four pillars to tenant screening, including:

  1. Credit score
  2. Income
  3. Rental History
  4. Criminal background

All four are important, but credit score and income are the main ones.

Those two are the easiest to uncover and verify. They are also the most objective rather than subjective.

Make Housing Affordable:

One thing that landlords must understand is that to be a successful landlord, you must offer affordable housing!

No if, ands or buts about it, if your tenant cannot afford the rent, it is not affordable.

If you’re rent cost is $3,000 per month then you’re tenants need to bring home ~$10,000 per month.  That is what affordable housing means to me and what it should mean to you!

I hear lots of stories from prospective tenants. They were a great tenant and the previous landlord doesn’t want them to leave but they were always late on paying their rent!

I always tell my renters that by definition, it is impossible to be a great tenant if they do not pay rent.

It must be paid in full, on time, every time!

It doesn’t take too much for a tenant to be two month’s behind on rent. On day one, they owe rent. On day two if they have not paid yet, then they are a month behind.

Thirty days after that they are already two month’s behind, which is a mere thirty days into a rental cycle, so it adds up fast. You want to make sure you are getting paid on time and in full.

How I Screen Based On Income

When I screen tenants on income I look for at least 3.5X the gross income in rent. Most of my places, which are three bedrooms, rent for an average of ~$1,025. The federal government recommends a family spend no more than 30% of their gross salary in rent.

That would equate to a $41,000 per year in household income. 3.5x the rent would be closer to $43,000.

I know the median household income in the USA, for 2014 is $53,043. That is, just as many households make more than $53,043 as below.

If you do not know what average is, you do not know what below average is.

Know it! Know it for credit scores and income at a minimum!

Why You Should Set Your Income Standard High

I cannot discriminate against familial status so I can’t say a working person with four children and a non-working spouse with no money in the bank, has to make more than a single person without children and $5,000 in the bank.

It makes no sense but that is the way it is.

I could use the money in the bank criteria but not the mouths to feed. The federal poverty rate definitions take familial status into account but  a landlord cannot. Everyone knows it takes more to feed six people than one.

I cannot charge more in rent just because you have children and I cannot have a different set of criteria for tenants without children.

Setting the income bar too high, at the median of $53K, might exclude one person households. Setting the bar to low at only 2.5 times the rent would bring in people that cannot afford the apartment.

The Low-Income Renter Calculator

Here is a typical situation with low income, low credit score renters.  They generally have unreliable cars.  That is generally to be expected, but here is how it affects you.

The cars break down. There are car repair expenses. They do not have emergency funds. Below is a  great word problem that all high-school (and below) kids should have to learn to calculate:

If rent is $1,000 and a car repair is $400, what is the amount you have left to pay your landlord (on time) after you pay for the car repair?

I went to college and minored in math so I understand how to create complex formulas. I know this word problem looks easy but to a low quality renter it is very complex.

Assuming you were going to have the $1,000 rent on the first of the month and your car trouble happened about that same time, my complex math formulas come up with a rent payment of $600.

It should still be$1,000 but it doesn’t always work that way. The renter calculator is a bit different.

The correct answer is $0. 

If you are lucky it may be $150, or $200, but it will never be $600. You will get the rest of the rent on the next payday if nothing else comes up.

It would never occur to them that rent should be paid first, before the car repair.

They need the car to go to work to make money to pay the rent, so that expense will always come first. How next month’s rent will be paid is also not a concern at this time.

The low-income renter calculator figures that if you are not going to pay in full why pay at all. Some is better than nothing and if all you are going to pay is some, why stretch it?

If this happens to you as a property manager it is your own fault, not the renters.

You loaned your renter an apartment that they could not afford. It is no different than the banks loaning mortgage money to homeowners who could not afford to pay the mortgage.

So, again, make sure your tenant has at least 3.5x the rent in income. Most of my professional renters make 10x+ the rent so they have no trouble paying on time, car payment or not.

I have some renters that make almost 20x the rent in income.

Preparing for Rental Increases

Another reason why to make sure your tenant has plenty of money to pay rent is for rent increases. If your tenant can barely afford what you are charging now, how are you going to get more rent from them in the future?

If they are government assisted maybe increased rents are an option but only if the government entity approves your higher rent. So, make sure there is plenty of money in the tenant’s paycheck for you when you need it.

Taxes, insurance, utilities and maintenance costs all increase so you need to keep your ROI and cash flow steady and increase rents with the expenses when needed.

When it comes to income, you can create all sorts of complex formulas to look at income vs. loan payments and do all sorts of complex analysis.

You can take into consideration car payments, credit card bills, outgoing payments of child support, etc. but I prefer to look at gross income only.

I do not look at outstanding debt. I do not have time for tedious analysis!

I just set the bar a bit higher and know they should have enough to pay rent.

Don’t Bother With Counting Child-Support As Income

So, when I get an application I first look at their credit score first because, well that’s easy.

Then I look at income. I do not count child support, as I do not know the payer of the child support’s background.

They are, after all, like a co-signer; they are effectively paying a portion of the rent. If they are paying rent in the form of child support, I need to know their credit score, income, job stability, etc. and I do not have time for that.

They will not normally give that information anyway, so skip it!

How I Handle The Self-Employed

I generally do not like self-employed people, unless it is a ‘solid’ business. I want a business that can be validated on paper, not some guy doing car work on the side.

If you are a consultant or professional, you will have bank deposits and checks from clients. You will have a business checking account, with a tax ID and deposits that I can verify.

You will have a tax return. You will have a solid credit score and you may have a larger deposit.

Remember, a tenant’s income will tell you the tenant’s ability to pay rent and the renter’s credit score will tell you the desire to pay rent.

You need both.

In Conclusion

I discussed how to use credit score to screen renters in a previous post. In another future post I will discuss the other two pillars, criminal backgrounds and rental history.

What do you use to screen renters?

This post was originally posted at
http://www.biggerpockets.com/renewsblog/2014/05/12/four-pillars-tenant-screening/

2 Replies to “The Four Pillars Of Tenant Screening”

    1. Thank you for the comment!

      It is the number one why landlords fail, bringing in tenants that are not only un-profitable. If you are under capitalized, and have a major expense due to the tenants, often a landlord cannot recover.

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