Bankruptcy and rent to income ratio

Plano, TX · Member since 2013 · 40 posts · 0 votes

A tenant that applied just filed Chapter 13 Bankruptcy several months ago and has a 600 credit score. His gross income is 4.6 times rent, but he has some after tax deductions (including bankruptcy payments he just started to make) which brings down his net income to 2.5 x rent. His job seems stable (with the same company for more than 10 years).

I have always used the 3 times rent rule for income, but don't know whether the bring home pay should be used for this guy. Your comments are greatly appreciated.

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Joel OwensBusiness Member

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Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes

12y

On chapter 13's about 90% of the time they never finish the plan. It gets dismissed sometime during the usual 3 to 5 year payment plan for non-compliance. Very few finish the plan and get discharged. This is why you will see BK attorneys front load fees on the re-payment schedule to get paid first.

A tenant that has completed a chapter 7 tends to be better as they are not carrying all that debt to repay like a 13.

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Elizabeth Colegrove
Hanford, CA · Member since 2013 · 5k+ posts · 1k+ votes
12y
@William C.

I don't rent to people in the middle of bankruptcy. I am always afraid that they will try to charge their debt to me in the bankruptcy. I have also found that while they might make great tenants. There are a lot of other tenants that will also make great tenants without any of these issues.
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William C.
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Plano, TX · Member since 2013 · 40 posts · 0 votes
12y
@Elizabeth C. That is a valid point. I've had a few prospect tenants that have filed BK before, but this guy just filed recently vs some people did it years ago. I also worry that this guy might not be able to pay rent timely since he is taking home substantially less than his gross income.
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Duncan Taylor
Real Estate Investor · Member since 2013 · 866 posts · 487 votes
12y
Originally posted by @Elizabeth Colegrove:
@William C.

I don't rent to people in the middle of bankruptcy. I am always afraid that they will try to charge their debt to me in the bankruptcy. I have also found that while they might make great tenants. There are a lot of other tenants that will also make great tenants without any of these issues.

I'm curious. What did you mean when you wrote, "they will try to charge their debt to me in the bankruptcy?
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
What you need to have to deal with an applicant like this is the debt to income ratio (DTI). Take home pay can be many times the rent, but if the monthly payments on those debts exceed the rent ...

It's easy for renters to have high monthly debt payments. Multiple car loans, student loans, rent a center payments, etc.
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William C.
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Plano, TX · Member since 2013 · 40 posts · 0 votes
12y
@Steve Babiak This applicant has a 17% DTI and his debt payments are less than the rent (but close). The debt payments are deducted from his pay check automatically, which makes his net income (after tax and debt payments) less than 2.5 times the rent. Do you think this is a red flag?

Thanks for everyone's insights!
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
If the debt payments are close to the rent amount, and you are using 3x the rent for monthly gross income, then that would seem to be a higher DTI than 17% - closer to 30%, since rent is close to 30%.

Add the debt payment to the net income and what does that get you in terms of multiple of monthly rent?
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Joel OwensBusiness Member
Moderator
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
12y
On chapter 13's about 90% of the time they never finish the plan. It gets dismissed sometime during the usual 3 to 5 year payment plan for non-compliance. Very few finish the plan and get discharged. This is why you will see BK attorneys front load fees on the re-payment schedule to get paid first.

A tenant that has completed a chapter 7 tends to be better as they are not carrying all that debt to repay like a 13.
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Marcia Maynard
Investor · Vancouver, WA · Member since 2013 · 3k+ posts · 4k+ votes
12y
Our minimum criteria is gross income 3x rent or 2.5x with additional security deposit. We will look at the debt and payment obligations to see if it is feasible the tenant could comfortably keep up on rent and utilities. Our main concern is the risk to us and what we can do to mitigate that risk. Higher security deposit? Asking for last month's rent in addition to first month and security?

Also, it depends on the property, the market, your rental agreement and the landlord-tenant laws applicable to your area. For us, we choose to use month-to-month rental agreements and can exercise 3-day pay or quit, 10-day non conformance, or 20-day no cause notices to terminate the tenancy if we need to. Our evictions take about one month and cost $600-$800. We factor that into the risk. Also, a tenant who finds many doors closed to them, may stay longer in a place that is more accepting.

Hmm... Your situation... 4.6x gross income and stable 10-year job (plus how many more years in same profession or line of work?), 2.5x after figuring in the payment plan he is on... Does it seem likely he could meet your requirement of paying rent and utilities? Seems possible to me. Bankruptcy doesn't scare me away from potentially good renters, though I wouldn't be loaning them money to buy a house. If they seem a good candidate otherwise, then just ask for the extra security you feel you need. We've seen some renters succeed at 2x rent. So it's all relative.
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William C.
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Plano, TX · Member since 2013 · 40 posts · 0 votes
12y
@Steve Babiak

I am checking the numbers regarding DTI

Monthly gross income $7493

Pre-tax deductions $1090

Tax $1145

After-tax deductions (include BK payments): $1277

Net monthly income $3981

The rent is about $1575. He has a family of four and no other incomes.

I am new to screening tenants and really appreciate any comments on his ability to afford the rent and utilities.

@Joel Owens

That is my concern too. This guy just started his BK payments last Nov. It would be hard to say whether he could finish the process. If he doesn't finish the plan, would he still be responsible for his previous debts?

@Marcia Maynard

Thanks for sharing your experience! The prospect tenant has agreed to pay 2x security deposit. He had 1 late rent payment at his current place and the current landlord did have to send a legal notice. He is moving due to job relocation. My lease term is 12 months. I am wondering whether month to month makes more sense to this situation.
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
Another option is an initial six month lease so that your renewal shifts to the summer - I like to say to align with the school year. That gives you some time to further evaluate. You can then renew for twelve months or end it if not going well.

It seems like there should be enough income being earned; it's just hard to predict what sort of spending might happen in the future. That's often how/why people end up filing BK.
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Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
12y
There is no issue with the rents and net income mentioned here. As net income increases ratios become less of an issue as the real question is can the tenant live on the disposable income?

Ratios are determined (as they were by HUD) based on a statistical basis with a national population pool over a large spectrum of incomes viewed in light of default experiences. Ratios are a guideline, not a hard and fast rule, especially as disposable income increases.

Many people give up other things to live in a certain area or a particular home, that may be more important to them than weekend travels, or other entertainment. Search the 3X the rent thread not far from this one.

Bankruptcy usually isn't an issue with rents unless you are evicting. They are some of the first expenses stayed by the court as they recognize living expenses. I can't imagine any cram-down of rents for any ordinary rental, maybe in a luxury unit in unusual circumstances. :)
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William C.
OP
Plano, TX · Member since 2013 · 40 posts · 0 votes
12y
@Steve Babiak

Initial six month lease is a great idea. I will talk to the applicant regarding this.

@Bill Gulley

Thanks for the info on rent and BK. The applicant really wants his kids to attend the schools of this community. So hopefully he will learn his lessons and spend prudently.

Thanks everyone for your insights! I appreciate all the help!
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