As a landlord, you can’t just assume that an applicant can afford to live in your property. In order to increase your chances of getting paid on time and in full, you’ll need to do some due diligence and uncover more information about their financial situation.
How to Evaluate a Prospective Tenant’s Financial Situation
Real estate investing—and landlording, in particular—is all about cash flow. In order to pay down your mortgage balance and cover costs like insurance, property taxes, and utilities, you need income.
Having a tenant who doesn’t pay on time or in full can be catastrophic. Thus, it makes sense to carefully evaluate a prospective tenant’s personal finances before entering into a lease agreement. Here are some ways to go about it.
1. Verify Income
As part of your rental application, you should be asking applicants how much monthly income they’re bringing in. But don’t take them for their word. Many people find it tempting to fudge the numbers a bit to secure a property they really like.
It’s completely legal for you to request income documentation. You can ask the applicant to photocopy a paystub, provide a W-2, or present a bank statement that shows recurring direct deposits.
For individuals who are employed (as opposed to self-employed), you can even take things a step further and contact their employer to confirm that they’re still on the payroll. This is known as an employment verification request.
2. Pull a Credit Report
It’s always smart to pull a credit report to see how financially healthy a prospective tenant is. A credit check will show you an individual’s credit score, how much debt they have, whether or not they’ve ever filed for bankruptcy, and—most importantly—whether they’ve ever been evicted.
3. Use Common Sense
With an applicant’s income and debt information on hand, you should use some common sense to determine whether or not you think they can reasonably afford to pay the rent.
According to Credit Loan, the average American family spends $18,886 per year on housing—or roughly 25 percent of the average pre-tax income. This can be used as a reference point. You may also want to calculate an applicant’s debt-to-income ratio, which gives you an idea of how much income they have left over after making minimum payments on existing debt each month.
4. Speak With the Previous Landlord
As part of the application process, you should be asking applicants to provide the names and contact information of previous landlords. Though some landlords view this as a formality, consider it an excellent opportunity to explore a prospective tenant’s past financial behaviors.
Call up the landlords listed and ask them questions about how often rent was paid in full, if it was ever late, and whether there were any red flags about that person on the money front.
Follow Landlord-Tenant Laws
Tenant screening is a sensitive topic. Many landlords are so fearful of it that they’ll accept almost anyone who fills out an application.
But don’t let it be a scary thing. By learning the rules, you can protect yourself and your investment. You are legally allowed to choose among prospective tenants as long as your decision is based on legitimate criteria.
“You are entitled to reject applicants with bad credit histories, income that you reasonably regard as insufficient to pay the rent, or past behavior—such as property damage or consistent late rent payments—that makes someone a bad risk,” attorney Janet Portman explains. “It goes without saying that you may legally refuse to rent to someone who can’t come up with the security deposit or meet some other condition of the tenancy.”
With that being said, you’ll get in trouble if you make inferences. For example, you can’t assume that someone is in an illegal line of work and that’s how they’re generating income. Without any evidence to suggest such a thing, you could face issues with discrimination. You also can’t make assumptions about someone’s income based on their skin color or the car they drive.
To deny someone for financial reasons, you need factual evidence to support your decision. As long as you’re able to point to something objective, you don’t need to worry.
Do you have any further questions or additional tips with regard to evaluating a prospective tenant’s finances?