When renting an apartment, you as the building owner must first want to make sure you are not discriminating against anyone or you could find yourself in court. It is important to have criteria that you stick with such as credit score, income and liquidity that are used for everyone who submits a rental application.
If a renter has a low credit score, but no late payments, look at the report for a bankruptcy, high balances, tax liens or judgments. The high balances could be a problem because the renter could be carrying a lot of revolving debt of which a portion — possibly a large portion — of their income is going to service (pay for the bills).
As an owner, you want to make sure the tenant can pay rent in full each month. At the end of the day, the owner is providing a service that the renter is paying for each month. If the tenant has an explanation that makes sense, and meets all the other criteria, you will have to make the final decision. Keep in mind that credit reports are delayed and do not show current information. Meaning a renter may have paid off large amounts of debt before moving that are not reflected on their credit report. Furthermore, a tenant may have had the debt for a purpose with a plan to pay it off on “x” date, that is why it is important to ask the tenant about the situation if they are truly someone that has met the criteria for renting.
Unfortunately, there are no hard and fast “FICO” scores to go by. Generally, anything above 650 is fine if the tenant does not have any other issues, the idea being a higher score is better than a lower score. However, for me, personally, I would sooner take a person with a 650 FICO and perfect credit over a person with a 680 FICO and late payments if all other factors were exactly the same. Late payments show that a person may feel that they can pay rent whenever they want. However, as many owners know, it is better to get the rent on time since there are expenses on the property that must be paid in a timely fashion.
A tenant’s income is obviously important, but in Los Angeles, there are many people who show little income or have erratic income. The former case usually describes individuals who work in restaurants or other cash businesses and do not report their income. The latter explains many people who do creative work and are paid per job. If the renter deals in a cash industry, you are going to have to request bank statements to show deposits that prove income. However, attaining bank statements to prove income can be unreliable as that person may choose to keep the majority of their money in cash on hand. If the individual does creative work and is paid sporadically, you can simply average their income over the last year. Ask for checking and savings accounts statements as well. Keep in mind, many people will pay rent first and make it a priority, as they will have no place to go if they are evicted.
Of course, you need to figure out what your requirements for income are going to be in relation to rent. This is a number you are going to have to become comfortable with when renting a unit. However, many investors use the 30 percent number. If you were renting a one bedroom for $1,000 a month, using the 30 percent number, the individual’s gross income needs to be $3,333 per month or $40,000/yr ($1000/.30 = $3,333). Just back into the number and use the gross income from all people living in the unit. For example, if you were renting a three-bedroom unit for $3,000, the total income per month from all parties would have to be $10,000 or $120,000 per year. In the latter example, make sure you take the gross income from all individuals living in the unit. If the tenant does not meet the income requirement, you can ask them to get a cosigner. Most of the time a cosigner will be a parent or relative, but in theory, it is anyone who is willing to shoulder the responsibly of the liability over the unit while the renter lives in it.
As far as liquidity, I touched upon it above. Liquidity is defined as any liquid assets such as cash, stocks or bonds. You can count a 401k as liquidity, but do not count the entire amount, as there is a penalty for withdrawing early. Decide what you want the liquidity requirement to be, if you even decide to have one. I have noticed that many renters do not have much cash savings, if any at all, but that does not mean they will be bad tenants, it usually just means they make just enough money to make ends meet. If you decide to count liquidity, be reasonable, as a month or two of rent is probably sufficient. Remember, the tenant is putting up a deposit as collateral.
As an owner, you want to get the best tenant you can in the unit, but keep in mind that there are laws that protect tenants from discrimination. Keep your renting criteria the same for everyone. If a person meets all your criteria, but you are concerned about one or two issues, speak with the individual. A conversation usually clears up any concerns. Remember, having a good tenant is a win/win situation because they have a place to live and you have an occupied unit.
Mike Heayn is a commercial loan consultant specializing in multi-family lending. He can be e-mailed at firstname.lastname@example.org.