The credit report will provide you with a lot of information about how your tenant handles financial responsibility and the house rules set forth in the lease. If you are not using credit reports, we strongly recommend that you start now. This is your first line of defense.
This article will look at the basic information in a credit report and consider each area of information to help you write a sample credit policy.
Name and direction:
You must verify that the name and address on the rental application match the credit report.
Confirm the above address on the application against the credit report
Use a valid driver’s license or other photo identification to help confirm visual identity. Using Driver’s License to Confirm Date of Birth
Social Security: A warning indicates an incorrect entry or identification problem. Request some other documentation that confirms the social security number, such as tax returns.
Financial Reasons Monthly income entry must be verified by recent pay stubs, a letter of intent to hire on company letterhead, or tax returns (if self-employed)
* Income to Rent Ratio: A mathematical formula that compares gross income to rent. It is helpful to determine if the prospective tenant is earning enough to provide a comfortable margin of rental income.
* Income to Debt Ratio: A mathematical formula that is useful in determining whether your debt load could interfere with your ability to pay your rent on time. It helps to know that your future tenant can manage the finances. Look at the income and look at the debt. This ratio can be helpful, but keep in mind that a mortgage can really create a misleading picture. Look at the commercial lines.
Lines of Business: The codes used by credit reports may vary from business to business, but there will be an indication of the type of loan. Mortgage loans should be high and will skew this relationship. You should allow this because home ownership is an advantage. Other business lines are installment loans and revolving loans.
Late payments: These guidelines will help you decide if your future tenant can pay without difficulty due to a high debt. It can help validate a bad relationship between income and debt. If there is enough money but late payments are indicated, you can consider whether this person is willing to pay on time. People manage money differently and you need to consider money management skills as well as ability to pay.
FICO Score – This is a mathematical compilation of your payment history, debt load, and much more. There are over a hundred variables that are used to provide lenders with a mathematical profile that they will use to determine good risk. Scores range from the low 300s to the 800+. The higher the score, the better the credit profile. * Different credit bureaus will use their own proprietary formulas, such as Beacon.
Public Records: This area contains bankruptcy records from the federal district and tax lien and money judgment records from state and county courts. You should look closely at this area, but ask your prospective tenant what the circumstances were. Serious money difficulties are a sign of trouble.
Eviction/Illegal Detainer: Eviction reports do not appear on the standard credit report unless there has been a money judgment. Get all the data you need to avoid a problem. This area indicates serious difficulties with another landlord and is certainly cause for rejection. Make sure the name and address match exactly. Often the scan will return similar names and it may not be your potential client who has been evicted.
Policy Considerations:
Income to Rent Ratio: Many owner/managers will be looking for a verifiable gross income of 3 times the monthly rent. You may consider combining the gross income of all residents in the unit to come up with one household income. You can consider increasing the multiplier when using more than one income to achieve the 3x qualification. Be sure to read our Fair Housing articles and treat everyone consistently.
Income to Debt Ratio: You should set a number that reflects your tenants’ ability to pay. Very high debt loads can make it difficult to pay rent on time. Establish a red line and apply it evenly to all applicants.
FICO Score: You may want to research the average credit score for your region to use as a guide to what is acceptable to you. Some average statistics as reported by Fair Isaacs (FICO Score developers) as of September 2005 are as follows:
1. Average number of credit obligations: Eleven
2. 30 day late payments – 40% have never been late
3. 60 day late payments – 20% has never been late
4. 90 day late payments – 15% has never been late
5. Non-compliance: 10% have never reported a non-compliance
Guarantors – When your guidelines are not met, you may need a guarantor or co-signer. It is recommended to have an application, verifiable income and a good credit report. You may want to consider stronger financial guidelines, since the guarantor would be responsible for both their own rent or mortgage and the applicant’s.
Public Records: Bankruptcies, bonds and money judgments are serious business. Generally, bankruptcy will not appear after seven years. If you are accepting applicants with these issues, you need to decide on a time frame. Is a bankruptcy or money judgment of more than two years acceptable? You may seek the advice of a real estate attorney.
Evictions: Is there a reason for an eviction? Set clear rules, write them down as a policy for everyone to see, apply them equally to everyone, and stick to them.
Howard Bell for yourpropertypath.com