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often make a wish list of the ideal neighborhood, fixtures and finishes, number of bedrooms and baths, and community amenities they want in their new home. Unfortunately, they may not always focus closely on their budget or they may be convinced that they will tighten their belt and cut expenses in order to afford a nicer place to live. Life is not predictable and expenses arise that cannot always be planned for. Part of the logic of evaluating the Rent-to-Income ratio during the rental application process is to make sure that the cost of the tenant’s housing makes sense in relation to their current income. That helps to keep renters from overextending themselves and entering into a rental agreement that they, ultimately, cannot afford to maintain for the length of their rental agreement.
Whether you are an individual landlord or a rental agent, you know that vacancies are a drain on your budget. You may be worried about filling a property, choosing to overlook weak financials in order to put someone in place and hoping for the best. After all, if a renter gets in over his or her head, that is their problem, right? This kind of thinking is shortsighted since it will ultimately cost you far more to struggle with, evict, and replace an improperly screened tenant than to wait for the right renter in the first place. Make sure that you do your due diligence so that the renter you put in place will be a perfect fit.
HOW DOES RENT-TO-INCOME RATIO FIT INTO YOUR OVERALL FINANCIAL REVIEW AND SCREENING PROCESS?
For a landlord or rental agent, Rent-to-Income ratio is just one part of an overall picture that you need to develop in order to properly evaluate your potential tenant. Other financial metrics you’ll want to consider include credit score and credit history as well as debt-to-income ratio. In addition, you will need to look at other factors to properly evaluate the potential renter. These include employment history, rental history, and criminal record. You will also want to consider references that are provided and consider lifestyle factors like pet ownership, smoking, and other requirements for the property, like lawn care.
It is important for you to develop and implement a consistent screening process for all of your applicants in order to avoid charges of preferential treatment or discrimination. Knowledge of and compliance with fair housing rules and regulations for your market is easier when you have a well- defined screening process in place.
CALCULATING THE RENT-TO-INCOME RATIO
There are two different ways to calculate the Rent- to-Income ratio depending on where you are in the tenant approval process. One is based on the property itself and the rent you would like to charge. The other is based on the gross income of a renter who is applying for a lease on your property.
PROPERTY-BASED CALCULATION
You have analyzed a rental property’s potential to determine the rent you can charge based on the property’s features and your local market. Based on this, you decide that you can charge $1500 per month for rent. In order to estimate what your ideal tenant’s gross monthly income will be, multiply the rent you are planning to charge times three to get a rough idea of the correct ratio.
Example: $2,000 rent * 3 = $6,000 gross monthly income or $72,000 gross annual income - Now, when you are reviewing a rental application, you can tell at a glance whether your potential tenant is in the correct ballpark financially for approval.
INCOME-BASED CALCULATION
Another way to calculate the Rent-to-Income ratio is to start with an applicant’s income and determine how much rent he or she can afford. In order to do this, you will multiply the tenant’s monthly income by 30% or .30.
Example: $4,500 gross monthly income * .3 = $1,350 rental payment - This allows you to work with a potential tenant to find a property that is affordable. This can be a smart way to calculate Rent-to-Income if you are managing a number of properties at a variety of price points since it allows you to help applicants find properties that fit their budgets.
WHAT IS A GOOD RENT-TO-INCOME RATIO?
Overall, the figure of 30% rent as a percentage of income is considered a good standard to shoot for, and indeed it appears to be about the right percentage on average, according to census data. Much of the “ideal” Rent-to-Income ratio is dependent on where you live since major metropolitan areas may see much higher ratios, sometimes as much as 50%.
Also, remember that Rent-to-Income ratio is a single criterion to consider when screening potential
CS-8 NOVEMBER 2021 - APARTMENT MANAGEMENT MAGAZINE
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