Interpreting Your Tenant’s Credit Report: What You Should Know
After a lease agreement, a credit report is arguably the most important document a landlord can learn to handle. If a tenant has a history of late payments or defaulting on debt, he or she is likely to do it again. Fortunately, running a tenant screening report or purchasing a credit check is a pretty painless process these days. But that’s the easy part. Deciding whether or not to rent your property to a prospective tenant is where things get tricky, and if you don’t know what you’re looking for, you’re doomed to end up with Joe “Default” Jones.
A tenant credit report is your best bet to determine whether a person will pay their rent consistently and on time. It provides an incredible amount of valuable information, the simplest of which is the credit score. But what do you do when you have one tenant with a score of 704 and another with 708? Both are good, but is there enough of a difference? Or, if there’s someone that seems like a great fit, but their score is lower than you would expect? Relying solely on a number you may not truly understand is risky. Knowing which questions to ask and what details to look for can make all the difference in your tenant screening process. Interpreting your tenant’s credit report properly is therefore key to finding the right renter.
A quick note: according to the Fair Housing Act, it is illegal to refuse to rent to a potential tenant based on the applicant’s race, color, national origin, religion, sex, family status, or disability. To avoid any risky violation, it’s critical that you establish a set of parameters that are important to you and stick to them.
Breaking Down the Different Components of a Credit Report
For starters, credit reports are different depending on who’s providing them and for what purpose. As a landlord, you’re better off finding a tenant specific credit service than relying on a generic one. Amongst these reports, you’ll consistently find five basic components. Each part provides data that can help you make an informed decision about a potential tenant. Let’s look at them one by one.
1) Basic Information – Typically, this is the very first part of the report. It includes the subject’s name, any former names or aliases, their current address, and any previous addresses. When relevant, it can even provide employment history and marital status. It is important to confirm that the information provided by your tenant on their rental application matches the information provided by their credit report. A dishonest tenant is NEVER a good tenant.
2) Fraud Indicators – These indicators will appear if the social security number entered does not exist or if the person to whom the SSN belongs has been reported as deceased. You’ll also see these if a phone number is invalid, if a commercial or institutional address is used as a personal residence, or if the SSN or surname doesn’t match what is on file. Keep in mind, the reason for an alert may be the result of a simple keystroke error or sloppy writing when the tenant filled out their application, so be sure to do some digging. If the issue is an address mismatch and they can provide a utility bill in their name, you’re probably okay. But don’t make any assumptions and don’t take their word at face value.
3) Tradeline Summary – The tradeline summary provides a snapshot of active accounts held by your potential renter. This includes things like credit cards, auto loans, and student loans. A good credit report will provide month-by-month details, so you can see if, when, and how frequently the subject has failed to make a payment on time. Further, by adding up the totals still due on the accounts and the timelines in place to pay them, you can get a better understanding of your tenant’s ability to make payments. They may have high earnings, but if they’re heavily indebted, your market rate property may be out of their price range. Paying attention to a potential tenant’s active tradelines will help you determine whether they’ll have enough income to cover rent.
4) Inquiries – Here, you’ll see a list of the companies that have viewed the applicant’s credit file during the last two years. This helps you get a better idea of the applicant’s credit activity and overall credit seeking behavior. If they are constantly applying for personal loans, credit cards, or new cars, it’s probably a bad sign. As a landlord, it is also important to understand how common credit activities impact credit scores and how long those effects persist. For example, opening a new credit card can immediately lower the subject’s credit score by as much as ten percent. This penalty will remain for three months. So, if a score is slightly lower than you would expect but the subject opened a credit card a week ago, you can be confident that the score will balance out soon. One last thing to keep in mind: only hard inquiries show up in this section. A soft inquiry initiated by the tenant will not appear. If you’re wondering what we’re talking about, check out this article on hard inquiries vs. soft inquiries.
5) Credit/Resident Score – A credit score is the simplest, most to-the-point piece of data in a credit report (that’s its purpose, of course). It is a numerical expression ranging from 300-850 used to communicate a subject’s creditworthiness. As we’ve already noted, there’s plenty of nuance to a basic score that should be accounted for with further digging. Fortunately, there’s something called a resident score that will do some of the work for you.
Like a credit score, a resident score is a numerical expression of creditworthiness but with the added specificity of a rental contract in mind. Also like a credit score, the formula used is proprietary and not available for examination. So, while we can’t tell you exactly how resident scores are determined, we can tell you that different factors are given different weight based on their relevance to rental housing. Reports with resident scores will also likely include a recommendation as to whether or not you should rent to the tenant. This is useful, but not gospel – find what works best for you. But, regardless, as a landlord, it’s best to seek out credit reports that include a resident score instead of a credit score.
Interpreting the Information
Now that you know what everything in your report means, let’s examine the specific criteria you should look out for. There are a few red flags that can quickly help you decide whether a potential tenant is qualified to rent your property or not.
Credit/Resident Score: If a tenant has a credit or resident score of 600 or less, there is usually good reason to worry. The most trustworthy tenant candidates will likely have a score between 700 and 850. You can use this chart to compare your prospective tenant’s credit score to the rest of the US population. Before moving on, it is still important to evaluate the credit rating for the applicant. If they have a consistent history of delinquencies, that’s likely to continue. But if their credit history is short, one late payment could tank their score. Once you know these details, it’s perfectly reasonable to ask the applicant for an explanation.
Frequency and Severity of Late Payments: The frequency of late payments tells a lot about an applicant. To be safe, you should rarely consider tenants that have made late payments more than 10 times, regardless of the length of their credit history. Pay attention to how late the payments are settled. A late payment is always bad, but a payment that comes in 100 days late is a lot worse than one that comes in just a few days after it was due. Also, if you see late payments on multiple accounts, it probably means the applicant is having consistent financial trouble or that they don’t take their debt seriously. These folks likely aren’t the greatest candidates. However, if several accounts had late payments at the same time, it could mean that the applicant had a single, major financial issue and recovered.
Total Monthly Payment and Income-to-Rent Ratio: Rent and monthly debt combined should never exceed 70% of total income. For example, if a tenant earns $2,000 a month, pays $500 in student loans and is attempting to rent an apartment for $1,000 ($500 + $1000 / $2,000 = 75%), you probably shouldn’t rent to them. Additionally, according to Federal Guidelines, a household that pays more than one-third of its gross income on rent and utilities is considered rent burdened. If a tenant is contributing more than half of their income to rent, they are considered extremely rent burdened. Just because a tenant drives a nice car doesn’t mean they have enough available income to rent your property.
Current Past Due Amount: Any past due amount is a concern and should be examined carefully. Find out why the tenant is not current on one or more of their obligations and if the explanation is not satisfying, move on. If the past due amount is equal to or greater than your security deposit or rental rate, it is probably an indicator that the applicant does not use their money wisely. You should be particularly cautious of these prospective tenants.
Digging Deeper: Looking Beyond a Tenant’s Credit
Evaluating an applicant’s credit report can help you make a reasonable assessment about their viability as a renter. If you understand what you’re looking at and what you should be looking for, you’ll be well equipped to properly screen your tenants. Add to this a well-constructed application and a background and eviction check, and you’re in a great position.
But bear in mind, these reports do not tell the whole picture. It’s equally important to engage with the tenant based on the information you find. If there is something that shows up in a tenant’s credit report that you’re wary of, or if a tenant informs you that they have bad credit from the very beginning, dig deeper. Why is their score lower than expected? Do they have a reasonable explanation for any red flags you’ve found?
Having a good credit score is important, but if a tenant can prove to you that they are honest, consistent, and verifiable in other ways, you might want to re-evaluate some of the other factors that initially made you uneasy. At the end of the day, you are the one responsible for setting the standards of your rental property. Knowing how to interpret a credit check is just another step you can take to ensure you’re getting the most out of your rental business.
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