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One of the toughest aspects of being a residential real estate landlord is choosing the right tenants. If you properly select tenants, you’ll reduce your hassles, and your investment will grow in it’s long-term value. You’ll also have a more cordial relationship with those who live in your property, which is good for everyone.
On the other hand, if your tenant selection strategy is flawed, or not systematized, you’ll make mistakes. This results in lost rental income, reduced property values, and more stress. You might even have to evict your tenants, or pay them to move out.
With strong tenant screening procedures, you’ll ensure a smoother investing journey. An important part of effective screening is understanding credit reports, and making wise use of the information which they contain.
Below, we’ve shared some of the main insights which we’ve gained, from years of screening tenants for rental properties in Los Angeles. Please keep in mind that you should consult with an attorney before implementing any screening procedures. It is important that your approach be legally compliant.
How High Of A Credit Score Should You Require For Your Tenants?
You might be wondering what sort of credit score you should require from your tenants. The score you set as your baseline will depend in large part on where your property is located.
If you’re in a more affluent area, with a lack of rental supply, you might require your tenants to have a score of over 650 or even over 700. In high-demand areas with many high earners, like New York City or Los Angeles, this is often the case.
On the other hand, if you’re in a less well-off region, with weaker job prospects, you’ll have to accept considerably lower credit scores. We know of property owners in less well off areas who frequently accept tenants with scores of under 600.
The best way to figure out the credit scores you should accept is by talking to other property owners in your market. You might also pretend to be a prospective tenant (yes, seriously) and call around to inquire about what sorts of rents various landlords are accepting.
Based on our market conditions, we typically require a credit score of 620 to 630 in order to rent at one of our properties. We’ve found that this score allows us to find quality tenants, while not excessively limiting our applicant pool.
Which Credit Scores Should You Use?
It is important to consider that there are multiple credit scoring models. The VantageScore is a scoring model which was created by the three credit reporting agencies. It’s the credit score you find on Credit Karma and other apps.
Here’s the thing: The VantageScore is less widely used than FICO scores. Various versions of FICO are used for mortgage loans, auto loans, credit cards and personal loans. FICO is also commonly used by landlords. In our experience, FICO scores are more rigorous and reliable.
There are multiple versions of FICO. Most rental screening platforms (more on that below) will provide you with some version of FICO – often a newer version like FICO 8.
Where Should You Obtain Credit Reports?
There are multiple resources which you might use to obtain credit reports. CoreLogic, Experian, SmartMove, VeriFirst and others. We’ve used multiple screening services, and have found that there are a number of good options for you.
Rather than focusing on any particular screening service, you want to see which features each service offers. Ensuring you’re using the proper features is the best way to ensure a smooth tenant screening experience.
First, you want to ensure the tenant screening reports offer three key components: Credit scores, eviction records, and criminal background records. We will focus our discussion here primarily on evictions and credit history.
Eviction History
With eviction records, our view is simple. We don’t accept anyone who has been evicted from their prior residence, or had an eviction case filed against them. Period.
This might sound like a harsh approach. However, consider the consequences of a non-paying tenant. You’ll spend money and time trying to evict this individual. It’s quite possible they’ll damage the property.
If someone has been evicted in the past, does that mean they’ll be evicted again? Perhaps not. However, given their prior history, why take a chance? There are plenty of other quality tenants out there.
Now, if you operate in certain markets or submarkets, specifically low-income areas, your options might be more limited. Evictions are an unfortunate facet of life for tenants in these areas. Where we purchase rental properties, we’re able to find high-quality applicants, who were not evicted in the past.
One option is to ask your tenants for an extra security deposit. Perhaps instead of one month’s rent, you ask for two months rent. Of course, many lower-income tenants might not be able to afford this.
Another option is to have your tenant provide you with a cosigner, who will guarantee the lease. If they can provide you with someone who has sufficient credit and income, you may reduce your rental risks.
Here’s the issue: Plenty of potential tenants won’t have someone who can guarantee their lease. If they do, there’s a strong chance that the guarantor isn’t qualified.
This leaves you with a few options. One, you might focus on investing in a higher quality market or sub-market, where you are less likely to encounter renters with prior evictions. This is what we’d suggest. Evictions are non-paying tenants are costly, and can be a constant source of stress.
If you are going to purchase in an area with a high eviction rate, and potentially accept tenants who have been evicted before, there are several safeguards you ought to consider. First, only accept tenants who have a consistent source of income.
In some cases, it can make more sense to choose those on government voucher programs (like Section 8). Since at least part of your monthly rental income is paid by the government, you don’t have to worry as much about a non-paying tenant.
Also, it is worth considering that an older eviction is of less concern than a more recent one. Obviously, it is ideal if your tenant was never evicted.
However, we worry less about someone who was evicted 5 years ago (and has maintained a clean record since) vs. an individual who was evicted in the recent past. It is very possible that someone with an old eviction has since improved his or her financial health. The same is probably not true of someone who was evicted more recently.
Credit History
When you’re examining credit history (outside of evictions), there are several things you ought to keep a close eye on. First, let’s look at what is of less concern when it comes to negative credit items.
Medical Bills
Medical collections accounts are the single most common negative item found on any individual’s credit reports. This isn’t surprising, considering that medical debts lead to countless Americans filing bankruptcy every year.
Here’s our view: As a property owner, you shouldn’t concern yourself too much with medical bills. There are a few reasons why.
First, medical bills aren’t typically debts which are incurred voluntarily. What does that mean? Well, most medical debts result from someone being sick, and needing medical care. There’s no real choice to take on medical debt. For this reason, it doesn’t really indicate whether or not someone is financially responsible.
This is somewhat unlike credit cards (which you sign up for voluntarily), or for that matter personal loans or a cell phone plan. Not paying those sorts of accounts can (properly) be seen as an indicator of being financially irresponsible.
Secondly, in our experience, many renters who have medical collections accounts are in fact quite responsible. Plenty of them can be relied upon to meet their financial obligations properly. The same is less often true of those with credit cards and other debts.
Auto Repossessions / Charge Offs
In much of the nation, it is quite difficult to get around without a car. That’s why so many of us buy our own vehicles.
We know that life happens. People lose jobs, or go through divorces. Still, so many folks do what is required to hang on to their vehicles.
We’ve found that those potential tenants who fail to make payments on their auto loans, and thus have their car repossessed, tend to also have trouble paying their rent. Again, this isn’t the case in every instance, but it is something we often see.
For this reason, it is often best to avoid renting to tenants who had their vehicle repossessed in the past. If you are going to rent to tenants facing these situations, you might want to consider obtaining an extra security deposit.
As with any other negative credit item, how recently a repossession occurred is very relevant. A rental applicant whose car was repossessed 5 years earlier, and has since had decent credit history, is much less of a concern than someone whose car was taken 6 months ago.
Credit Card Charge Offs & Personal Loans
When you borrow money, you want to make a strong effort to repay what was borrowed. This might sound like a simple principle, but when folks run into trouble, it can be rather difficult.
If a rental applicant has credit cards or personal loans which were charged off, we would suggest treading carefully. If the amount owed is just a few hundred dollars, and it was a few years ago, this might be less of an issue.
On the other hand, if the unpaid debt is for a larger amount, or is more recent, you’ll want to be cautious. A large debt can lead to a lawsuit against the debtor, which can result in their bank account being frozen or wages being seized (i.e. garnished). This can make it tougher for the debtor (your tenant) to pay their rent.
What about paid charge offs and loans? These are less of a concern. Even if the rental applicant ran into trouble in the past, they later resolved their issues. That’s a good thing.
Again, so much of this comes down to where you are acquiring properties. In a less well-off area, you must assume that you’ll end up with tenants who have more credit issues, and thus you’ll need to seriously consider applicants with damaged credit.
None of this is to say that you shouldn’t operate in areas which are less affluent. We’ve found it very profitable to invest in lower-income areas in Los Angeles. However, you need to be comfortable with tenants who have more financial issues.
Student Loans
With around 46 million Americans having student loan debt, it’s quite possible that you’ll encounter a rental applicant with student loans on their credit report. This in itself might not seem surprising.
However, what about student loans with late payments – or those which were charged off and are now past due? How should you deal with such accounts?
In our view, student loan defaults aren’t a big deal. School has become more and more expensive these days, and plenty of people don’t complete college. While it would be ideal if everyone paid their student loan debts, we also know that when people are younger, they sometimes make decisions which are not quite wise.
No Credit
What about someone who doesn’t have any credit? That is, they simply don’t have a credit score.
Perhaps they are newer to the country, and have not yet had a chance to build much credit? Or, maybe they just never really saw a need to use credit. Whatever the reasons, you don’t have much idea of whether this person is in fact a worthwhile credit risk.
In these situations, we’d suggest that you look at their overall rental application. How’s their income, and how much money do they have in the bank?
The stronger the rest of their profile, the more likely they are to be a strong tenant. On the other hand, if they barely meet income requirements, and have no credit, you might want to look for a different tenant.
The Final Word
Screening for tenants isn’t easy. There are quite a few factors which you must take into consideration. You don’t want to overlook factors which are important, but you also want to avoid excluding potential tenants unnecessarily.
The criteria discussed above have served us well. We’ve found that while medical bills and student loans aren’t really demonstrative of whether a particular rental applicant will be a good tenant or not, repossessions, evictions and credit card charge offs often are.
Screening well for tenants is amongst the most crucial aspects of successful rental property ownership. Learn the right approach, and your investments are likely to succeed for many years into the future.
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