Careful vetting of applicants is key when a landlord needs to fill an apartment vacancy. Doing your due diligence is critical to help find the best applicant for your vacancy. Determining if an applicant can afford the rent starts with their rent-to-income ratio (RTIR).
So, What Is the Optimal Rent-to-Income Ratio
Can the prospective tenant afford the rent? The best way to do this is by calculating their rent-to-income ratio. This means that you’ll verify the tenant earns enough income to pay the rent each month.
Typically, a good rent-to-income ratio is around 30%. In other words, the tenant should only be paying 30% of their income for rent. This ratio ensures they will have enough money to pay their rent and pay any other expenses they might have each month.
A lower rent-to-income ratio will also ensures they have enough disposable cash each month to help them cover the rent during a variety of differant economic times.
Where Did 30% RTIR Come From?
Financial experts didn’t just choose the 30% maximum for rentals through an arbitrary decision. Instead, the U.S. Department of Housing and Urban Development (HUD) has recommended this limitation.
Based on decades of data, the agency has determined that anyone who pays more than 30% of their income for rent each month is “housing-cost burdened” and faces a larger risk for homelessness.
When a tenant must pay more than the standard 30% for rent, a bad month can keep them from making rent payments on time. A need for medical treatment or another financial emergency can leave them unable to pay their rent. Once late fees and penalties kick in, the tenant can face a bigger financial burden.
Exceptions to the RTIR
As the RTIR is a general guideline there are some situations in which you can choose to overlook a poor rent-to-income ratio. For example, a tenant who can pay the year of rent in advance would obviously have a much lower risk level. You can also consider renting to someone in this situation if they can pay a larger security deposit or sign the lease with a co-signer. Another consideration is the prospective tenants savings.
The Rent-to-Income Ratio Formula
The equation for determining the rent-to-income ratio is simple. Divide their annual income by 12 and multiply that number by 0.3.
Consider a candidate who earns $100,000 annually and wants to rent your apartment for $2,000 a month. $100,000 divided by 12 is $8,333 per month. Multiply that number by .3 to calculate 30% of their monthly earnings. In this case, 30% of $8,333 is $2,500. In this example the candidate has a good rent-to-income ratio.
What Is the Income Target Alternative
You can simplify things for yourself by selecting an income target since this will save you from having to calculate the rent-to-income ratio for every candidate. This alternative involves setting an income target that will ensure your tenant can afford their rent.
A common strategy is to require that each tenant earns three times the monthly rent amount. If your rental unit is $2,000 per month, multiply that number by three. You’ll find that a tenant must earn a minimum of $6,000 each month to qualify for the rental.
Other Considerations –Debt-to-Income
Digging deeper, you should also look at each applicant’s debt-to-income ratio, which compares their loan and credit card debt to their monthly income. Even though you might have determined a candidate has an excellent rent-to-income ratio, a high debt load may adversely affect their ability to pay the rent.
On the other hand, someone with little to zero debt can have a rent-to-income ratio of 40% or a little higher. In this situation, you should look to other factors, such as their credit score and the number of accounts the applicant has in collections. All these factors can help you make a better-informed decision about your applicant.
