When you need to fill a vacancy, you will have to start vetting the applicants. Although this is a tedious process, being thorough can help you choose the best applicant for your vacancy. An important part of selecting a new tenant is ensuring they can afford the rent, and that’s when evaluating their rent-to-income ratio becomes important.
What Is the Rent-to-Income Ratio?
If choosing a tenant for your rental property, you will want to make sure that tenant can afford the rent. The best way to do this is by calculating their rent-to-income ratio. This phrase simply means that you’ll verify the tenant earns enough income to pay the rent each month.
Typically, a healthy 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 leave them enough disposable cash each month to help them cover the rent during difficult economic times.
Why Is 30% the Magic Number?
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.
When Doesn’t the Rent-to-Income Ratio Matter?
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.
How Do You Calculate the Rent-to-Income Ratio?
You don’t have to be a financial analyst to determine this ratio. In fact, 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 $75,000 annually and wants to rent your apartment for $1,800 a month. $75,000 divided by 12 is $6,250 per month. Multiply that number by .3 to calculate 30% of their monthly earnings. In this case, 30% of $6,250 is $1,875. This candidate has a good rent-to-income ratio.
Choose 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 $1,800 per month, multiply that number by three. You’ll find that a tenant must earn a minimum of $5,400 each month to qualify for the rental.
Debt-to-Income Ratios Make a Difference
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.
Conversely, someone with little to zero debt can have a rent-to-income ratio of 40% or a little higher. In this situation, you should lean on other factors, such as their credit score and the number of accounts the applicant has in collections. These factors can help you make a better-informed decision about your applicant.
Let Us Help You Find the Best Tenants for Your Rental
Landmark Property Management has the infrastructure in place to vet potential tenants. Give us a call to find out how we can fill your rental vacancies faster and with a better quality of tenant.
Named one of the Best Property Management Companies in Chicago, Landmark Property Management is a full-service brokerage with a reputation for going the extra mile for our clients. If you need help, have any questions, or are interested in learning from the best property management company in Chicago, don’t hesitate to reach out! You can contact us at Landmark Property Management via phone at 312-313-8553 or send us an email at email@example.com.