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I know many landlords, and despite my success at screening and selecting tenants, they often think somehow their property is different from mine. They do not think they can use credit score as a reliable indicator. They are ignoring credit score to their own peril.
The fact is, credit score is the most reliable indicator of tenant success that there is, bar none. You need to make sure that the tenant can afford the unit with an income of 3.5x the rent, but credit score will weed out the people that have behavioral issues and have no problem cheating anyone that they owe money to.
If you are a landlord, you know you need to do a background check. A critical piece is getting a credit report, complete with a credit score. The credit score is a summation of everything that goes on a credit report. It is calculated the same every time, with no bias to any discriminatory practices. It is colorblind and not subject to any fair housing issues.
Use credit score, without fail, as a deciding factor to include or exclude candidates for your rental. You should still have criminal criteria and other factors, but use the credit score as a line in the sand. Some landlords like to create their own score, somehow, by looking at the details on the report. This is a system fraught with errors and can lead to a high-risk situation.
A solid credit score tells you the tenant stands behind their word and cares about their reputation. It will give you great insight into a tenant’s personal behavior. You need to make sure every adult passes your credit standards, not just the primary lease signer.
I primarily look at the credit score, not the individual details, as that is the summation of all of the details on the report. Make sure you know what score you are getting. I use a report that shows FICO score, which ranges from 300 to 850.
I do look over the entire report to see any other potential issues that may be coming up. Of course, the report is only as accurate as the information provided.
What is on a Credit Report?
There are many different agencies that create a report, and different companies use different formats. There is only one company that has a FICO score, and that is the Fair Isaac Company. Many companies, such as Equifax, TransUnion, and Experian use this score, but not exclusively. Regardless of the format of the report, here are some things you can look for.
The basics are there. All accounts that are associated with the social security number are on the report. I am sure that at some point unused dormant credit drops from the report. They will show delinquencies and on-time accounts. Watch for recent accounts being delinquent, and watch for small balances showing up. If you bail on a cell phone contract, it shows up. If you do not pay the light bills, it shows up. People who cannot pay small bills are high-risk.
You need to understand the past address section. People who have too many addresses in the past five years are high risk. If someone has three or more addresses in the past five years, you may want to avoid them. They move too often for you to make a profit. Why is it necessary to move every year or two? It may be legitimate, but it could also be a forced move situation. The credit score will shed light on the reasons, regardless of what the tenant says the reason is.
You should also check if the addresses on the credit report are the same addresses that are on the application. Did the applicant conveniently forget one (or more)?
When you owe a company money, it could be due to a dispute on the bill. It may make for a late payment mark on your report. It may go into collections, or the company may write off the amount owed. If the collection is a landlord or apartment complex, it is a huge red flag. Knowing the names of the complexes around your area will help you identify apartment collection entries on the credit report.
Are there a lot of medical collections? A medical issue is one of the few things that cannot be anticipated. Of course, having decent health insurance and an emergency fund helps you anticipate…
Virtually all collections are a result of the tenant saying to someone that they will pay, and the tenant did not. Cell phone collections are a huge red flag. It is generally a contract that was skipped.
Other Credit Inquiries
This section will tell you what companies have inquired to a person’s credit. If you see other apartment complexes recently checking, it is likely the applicants were declined by them. Or maybe the tenants changed their mind and went somewhere else. If you are still considering renting to these people, you have to re-check your analysis to see what the other company might have seen and you have not. Or ask the tenants.
Related: The Four Pillars Of Tenant Screening
If there are a lot of recent inquiries from car loan companies, cell phone companies, etc., your applicant may have some financial trouble or may be looking to pick up more debt. It could be a red flag.
Debt to Income Ratio
This will list the balances to the high credit ratio. How much more capacity does the applicant have if they need money? If there is not very much “room,” their next emergency could be yours.
I do not put a lot of faith in this number, as I have seen high balance cards that are not used or car loans paid off, and it appears to be a distorted number on some reports. You should use this number in combination with the other information on the report.
Number of Good vs. Bad Accounts
Most people should not have any bad accounts. The longer a person has credit, the more accounts they will generally have. If you only have 2 accounts, it’s easy to keep them paid and get a 700+ credit score.
When you have 30+ accounts over your life, and they are all in good standing, it is a much better indicator.
If they have more bad accounts than good, it is a big problem.
This section lists all accounts, balances, and payments. I have seen cases where a payment amount is shown, and no balance. That indicates a paid off account.
I look at this just to see how much the person is already paying each month. I also look for accounts with recent activity, not old accounts. The number of days delinquent for 30/60/90 days is shown, as is current status.
It lists student loans. Student loans that are in deferment are counted as a good account. Nothing is payable until school is over, so the account is in good standing. When an applicant avoids paying a student loan that is in the payment period, it is typically serious. This loan MUST be paid; it does not even go away in bankruptcy. Most of the time, student loan payments are relatively small. It is an accident waiting to happen to see student loans not being paid.
You can see if an applicant had a mortgage, a car loan, or even utility bills paid on time. Generally, a person who had a mortgage is a decent risk — or they were at one time, anyway.
There is a lot of detail on a credit report, and each background check company might provide a slightly different report. Be sure to understand what you are getting and how to read it.
Are there some problems with some credit reports? Sure there are. The majority of the credit reports are correct, and even if they should have issues, the issues are rarely significant. Use a credit report like a grade report that is sent home to your kids from their teachers. Did they pass or fail?
[Editor’s Note: We’re republishing this article to help our newer landlords find the best possible tenants.]
Do you look at credit score of ALL of your tenants? Or the entire report? Or just the primary lease signer?
Leave me a comment and let’s talk!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.