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Your Landlord Resource Podcast
Your Landlord Resource Podcast
Analyzing Credit Reports For Tenant Selection
The process of vetting a prospective tenant is likely one of the most important tasks a landlord has.
Think about it. The person you place to live in your unit needs to have personal and financial characteristics that meet your rental criteria.
For us that means they need to have two positive referrals from previous landlords, a credit score of 725 or above, and net income that is at least 2.5 times the rental amount. But that’s just our qualifiers.
Because income is such an important part of the investigation process for this prospective tenant, we spend a lot of time looking at their credit report.
Sure, it’s likely that if they have our required score they will qualify, but we look deeper into the report to look at debt and if after paying that debt, will they have enough money to still pay rent to us?
In this episode we discuss what we look for when reading someone’s credit report, because it’s a whole lot more than that one little FICO score.
LINKS
👉 Rent Reporters: According to TransUnion, 70% of tenants are more likely to pay rent on time if their payments are being reported to the credit bureaus.
👉 TenantAlert: They provide the ONLY instant tenant screening service with LeaseGuarantee. The credit screening company with options AND guarantees.
👉 TurboTenant: Is a great option for landlords with just a few doors or for those who may be new to using rental property software.
For the most part, TurboTenant’s software is free to use so they are perfect for landlords on a tight budget.
👉 FTC Tips for Landlords: Using Consumer Reports, What Landlords Need to Know.
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So the one thing we want to make clear with our episode today is that a credit report is so much more than the FICO score. It tells us about an applicant's debt, if they're paying it on time and if they have enough money left after paying those debts to pay us our rent. And this is the reason why landlords need to really learn how to read a credit report
Welcome to your Landlord Resource Podcast. Many moons ago, when I started as a landlord, I was as green as it gets. I may have had my real estate license, but I lacked confidence and the hands on experience needed when it came to dealing with tenants, leases, maintenance, and bookkeeping. After many failed attempts, fast forward to today, Kevin and I have doubled our doors and created an organized, professionally operated rental property business. Want to go from overwhelmed to confident? If you're an ambitious landlord or maybe one in the making, join us as we provide strategies and teach actionable steps to help you reach your goals and the lifestyle you desire. All while building a streamlined and profitable rental property business. This is your Landlord Resource Podcast.
Stacie:Well, hey there, landlords. This is Stacie, and I'm sitting here with my trusty sidekick, Kevin.
Kevin:Hello there, everyone.
Stacie:So, the last couple episodes have been focused on leaving your 9 to 5 to work full time on your rental properties and then how to retire using the income from your rental income earned. This week, we're getting back to the basics and talking about how to read a credit report when you're vetting a potential tenant. So private credit reporting agencies collect and sell credit files and other information about consumers. And many landlords find it essential to check a prospective tenant's credit history with at least one credit reporting agency to see how responsibly the applicant manages their money. And we are among those who think that this is an important and we're here to talk about the process a little bit today. So many years ago, I would run credit reports on applicants and only pay attention to the FICO score. And we had stated in our criteria that applicants must have a credit score of 725 or higher to apply for one of our rentals. If the credit report popped back with that number or higher, I would just automatically move them onto the continue with the background check pile. Little did I know that I was setting our company up for problems by not investigating further into their financial background and evaluating what else was on that applicant's credit report. And I learned really quickly that knowing how to read an applicant's credit report is a lot more than just that FICO score. And those are the items that we're here to discuss today.
Kevin:Yeah, that's right. I mean, a credit report contains a goldmine of information for a prospective landlord. You can find out stuff like if a particular person has ever filed for bankruptcy or has been late or delinquent in paying rents or bills, including student loans or car loans. Or involved in another type of lawsuit, such as a personal injury claim, or if they are financially active enough to even establish a credit history. So let's first talk about that FICO score Stacie mentioned and how it's generated. The FICO score is the most commonly used method to determine an applicant's credit worthiness and the scores range from 300 to 850. The score suggests the risk that an applicant will default on rent payments with a high score indicating less risk. And generally, any score over 650 is considered medium risk or less. There are five areas of one's financial background that contribute to a FICO score. Okay, so first is payment history. This holds the most weight on the score with 35 percent of the score based on how well payments were made per agreement. Next is credit usage. The second most important factor at 30 percent to a FICO score and it's how much available credit is used. Length of credit is 15 percent of a FICO score and it's generated from how long you've had established credit for each line of credit or the age of open accounts. Next you have credit inquiries. That is 10 percent of the score and that measures how many hard credit inquiries or new accounts have been opened. And then finally you have credit mix. It's the last 10 percent and it's attributed to the applicant's various types of credit. The more diverse, the better in this case. Now, the information not included in a credit score would be such items as income. Where some reports will give estimates, it's essential to get copies of the applicant's pay stubs. The next item not on a credit score is employer information. You want to always confirm employment with human resources. You also rarely see credit information on their monthly rental payments. Like I said, it is rare, but we've been seeing more of it. This relatively new service is one that few landlords are offering to their tenants. The tenants must opt in for their landlord to report timely rent payments to credit agencies. And it's actually a good opportunity for those with little credit to help build their score and financial background. It also helps the applicant and any new landlord when they apply to be a tenant in a new home. When we can see their rent payments have been on time, it takes a lot of pressure off if knowing the current landlord is being honest with their referral or not.
Stacie:Yeah. Let me jump in here and express that if any of you are low income Section 8 or student housing landlords. Yeah. You should be offering rent reporting as a service to your tenants. We've had student housing for many years and use rent reporters for our service. They are free for the landlord and really easy for tenants to use and set up. So we will link them in the show notes so you can check them out.
Kevin:Yeah, the kids got off to a great start on their credit, and it really helped them when they had to transition into actual rentals after graduation and not student housing. Okay, evictions, civil judgments, and tax liens are never on a credit report. In 2017, the big three credit reporting agencies settled a lawsuit requiring credit reports no longer include evictions, forcible detainer, and unlawful detainer judgments, like civil judgments. It was deemed these items do not contribute towards credit. However, you can add this nationwide search on to most credit reports purchased for a fee Credit reports will not include tenants currently undergoing eviction due to the timing. This is the reason why you must speak with the last two landlords or property managers listed on the application. Because the current landlord may want to get the tenant out and choose to tell you how great they are so you can take their problems off their hands. Loan deferrals are never included due to the CARES Act. Credit reports include all loans, but it is up to the applicant to provide proof of this if deferred. Check writing history is hit or miss on credit reports. Usually if a tenant writes many bad checks to stores, you will not know. However, if they bounce checks to credit cards, car loans, et cetera. you'll know by looking at the payment section for each vendor as the payments would be posted as late. A few credit reporting companies do include check writing as a separate report. We will let you know which companies we use and offers this service in a moment. Now lastly, bank balances will not be included in credit reports. Where this information is essential for your financial background check, the applicant must provide bank balance verification to you. Can they be altered? Absolutely. But you can cross check what is on the bank statement to what is on the credit report. For example, are their$350 car payments made on time? Deductions for all debts on the credit report should be found on the bank statement. Income or direct deposit once a month or every other week? You should find that on their bank statements too.
Stacie:So the one thing we want to make clear with our episode today is that a credit report is so much more than the FICO score. It tells us about an applicant's debt, if they're paying it on time and if they have enough money left after paying those debts to pay us our rent. And this is the reason why landlords need to really learn how to read a credit report, because you don't want to put too much stock into that FICO score alone. You still need to do a thorough background check to see about their other characteristics like their ability to get along with neighbors or take care of your property. But I digress. So now that you have some background information on how the FICO score is determined, let's talk about items landlords should be paying attention to when reading a credit report. It's important to know if they have a high level of debt or not. Focus on their account balances and the monthly payments. A good credit score can mean that they pay their debts on time, but it does not mean that they have enough money left at the end of the month to afford their rent. The higher the debt, the lower the income that's available to pay you. Usually, all credit reports will have a credit summary, and this is the easiest way to get an overall view of their monthly credit available and debts that are owed. The total balance equals mortgages, revolving credit, and installment payments. The monthly payment equals the total amount of all minimum payments due to creditors each month in order for them to stay current. So it's also important to look at late payments. This area of the credit report can include not only late payments, but also collections, charge offs, repossessions, foreclosures, and bankruptcy. Below each creditor, you're going to see a 30 60 90 to show off if there's been any late payments in the last 90 days. The monthly bar at the bottom of each creditor shows how many payments they've made on time in the previous one to two years. And you like to see this as all green months. You're looking for unresolved negative trends, basically. Maybe last year there were several late pay items, but they've been on time this whole entire year. It's worth asking the applicant why for clarification. Uh, we've had to do this in the past and for the most part, they were honest and said they were either in between jobs or gave a valid excuse as to what had happened.
Kevin:A good example of this is divorce. That's another reason we'll see. Many people with joint credit accounts are told by their lawyers to not pay off any debt and wait to see after the settlement who pays what. This destroys people's credit, so you might find they have settled everything and have been paying on time for a while now.
Stacie:Yeah, not the best strategy, but divorce and even illness are both very difficult to cope with, so no judgment. Just stick to the facts in front of you. The last thing about late payments is if the account notates past due amounts due. It is already getting to be sent to collections, which is a liability. And again, ask for clarification if there's only one negative mark on the report. If you see account closed by grantor, see if there's any remarks for more context. For example, there may be an issue of a stolen credit card or their account was hacked. And also they may not have used the line of credit for many years and the account went dormant so the company just closed it. This information is not always there, but you can certainly ask the applicant why the account was closed.
Kevin:And sometimes you'll see the word collections. Look at what type of collection it is. Medical used to be quite common, but those are no longer allowed to be included on the credit report. The most crucial collection accounts are credit cards, utilities, or by a property owner. Always research the creditor's name to see who it is they owe. A rental property owner or a property manager could mean an unpaid judgment or damages that had exceeded the security deposit retained. Look for when the collection was assigned. Again, the farther back it is, the less impact it'll have on the report. The current status is significant to note. If it states paid, it shows the applicant is responsible and paid their debt. Unpaid can mean differently, but it's best to check with the applicant to see why it wasn't paid. Now this next one is important. When you see profit loss charge offs, the recent balance is the most important part to note here. A charge off is when an account goes into collection and after many failed attempts, the company just gives up and writes the amount off as bad debt. This charge off will stay on a credit report for seven years and damages the FICO score. Take a minute to look at the remarks, past due amount, latest activity, and most importantly the recent balance. The current balance is the most important to note as it is the total amount, which is balance plus late fees, that is being written off. The next one we don't see too often or actually barely at all and that's repossessions. They can also be known as reformations. Typically repossessions apply to autos but can also be to a boat or a motorhome, something like that. Payment status usually states UKN, which means unknown. Once an asset has been repossessed, the credit bureau removes the payment status. However, you can deduce the date they stopped paying by looking at the monthly payment, how much the remaining balance was and how long they have had the loan out. If a loan was taken out in 2019 and most of it shows paid, this issue is three to five years old and may no longer be a concern. But again, ask the applicant what happened. Like we said, maybe there was a divorce and the other spouse stopped paying. Perhaps the asset was totaled in an accident and the insurance coverage was not enough to pay the balance. There may be very reasonable explanations that the credit report may not state.
Stacie:All right. We have a few more items of what to look for on a credit report. And let me talk about warnings of mismatched information. So sometimes you'll see a section at the bottom labeled AKA or also known as. This area can refer to a person's last name if changed, like a maiden name or defining a junior or senior between father and son. And what's essential to check is the last four numbers of the social security number and the date of birth. If the social security number of the 28 year old applicant listed is correct, but the date of birth on the report states the person was born in 1959, you likely have an imposter. We haven't seen this personally, but we do know of a family that this happened to. There was a father and son who were senior and junior with, well, the exact same names. The daughter in law got a hold of the father's social security number and applied for a large line of credit in his name. She asked the son, her husband, to sign the papers as if they were under his social, and she went on a huge spending spree. She went to Hawaii with a girlfriend, bought new kitchen cabinets, which the guy gladly installed, and then when the balance got to be too much, she stopped paying. And the guy knew no better because his credit was not affected in the least. The whole thing was found out years later when the dad was denied credit for something. And he was baffled. When he asked what happened, the bank asked if he ever lived at the address, which was also his son's. He said, no, that's my son's house. Then they asked if he had ever had such and such credit card, and again, the answer was no. They asked if he'd been to Hawaii and had he rented a Ford Mustang. Again, no. And had he purchased a full kitchen worth of cabinets? And then he knew what had happened. He actually thought it was the son's doing and found out much later that it was the daughter in law who claimed, she must have mistakenly put the wrong social security number down. Uh huh. There are some really crappy people in this world. So, that's our story on why to pay close attention to birth dates on a credit report. This area of the credit report is not always a red flag, but more a heads up to pay attention. If you're concerned about the social security number, you can verify it by requesting a copy of their most current W 2 or tax return. There are also companies online that you can pay for their service to verify a social security number.
Kevin:Honestly, if you get to this point, you should be asking yourself if this tenant is the best fit for your rental. Okay, now let's talk bankruptcy. There are two forms of bankruptcy, Chapter 7 and Chapter 13. Let's Discuss the differences. Chapter 7 bankruptcy wipes out all of a person's debt and after approximately 4 to 6 months, all debt except taxes, student loans, government support, and alimony are removed from the credit report. Also, Chapter 7 bankruptcy stays on a person's credit report for 10 years. Therefore, it is essential to note the filing of the date of bankruptcy to determine if the applicant has recovered financially or not. Now, Chapter 13 does not wipe out all debt, and the debtor gets an opportunity to restructure finances and pay back all monies owed. They also get to keep their assets such as a car or home. This restructuring typically takes 3 to 5 years to complete and stays on a credit report for 7 years. However, Chapter 13 affects how the applicant can pay rent, as the restructured debt is still a liability, so make sure you pay attention to that amount and see if with it they can still qualify. Now speaking of qualifying, one of our criteria is an applicant must have a minimum two and a half times net income to rent ratio, meaning not using the gross amount before all taxes and deductions are removed. The net amount they take home is what you want to look at. This amount should allow for enough money to pay rent, utilities, and whatever their debt is while still leaving enough for basics like food. Okay, the last item on a credit report to pay attention to is inquiries. This significant area here will show how many lines of credit the applicant has applied for in recent months. Credit checks by landlords are soft pulls and are not typically included in inquiries. Usually, this would be for auto loans, credit cards, et cetera. And the number of inquiries will affect their FICO score under the new credit section.
Stacie:And we know that one for sure because a couple months ago, we put in for a new credit card and Kevin put it in his name, didn't affect his credit at all, but he put me as a, a signer on the account and my FICO score dropped 30 fricking points. I was so pissed. So, that's what inquiries will do to your, uh, credit score.
Kevin:Do they know what you do with that credit card on Amazon?
Stacie:Well, I guess they do. Okay, so that area is significant because if they are shopping for a new car, it is possible that it either had just gone through and hasn't posted yet, or they're going to be buying one soon. And this is something to consider when you're trying to determine if they can afford to pay your rent each month. Now, let me touch really quickly on one more item you should pay attention to on an applicant's credit report, and that is the previous addresses. Use this to verify that they match what's listed on the application. They should match those listed in theory, but this is not often the case. Unless the applicant formally changed their address with their creditors to a new address every time they move, they may not be noted on a credit report. For instance, a college student likely has their credit card registered to their home address, but they will list their previous address and landlord for verification. If you cannot determine how the address matches up to the applicant, ask them because there is likely a reasonable explanation. All right, now I want to move on to our thoughts on allowing an applicant to provide their own credit report. And for us, that is a big no way. We do understand there are states that require landlords accept them, and if you live in a state, say, like New York, where landlords have to accept a credit report from the applicant when provided, just smile, say thank you, and then go run your own credit report and pay for it yourself. It is way too easy for sketchy applicants to alter documents these days. Can they modify all requested documents? They sure can. If you run your own report, you'll be able to verify the date of birth. You'll also be able to compare it to the application they provided. Hopefully, it'll all pan out, but personally, we are leery when applicants provide their own credit reports. They still have to pay an application fee. So just use those funds to run your own report, but that's just what we do. Also accepting or using Credit Karma reports is not a great idea. They use a different model to create their credit score and it's often not very accurate. It's credit score number is typically higher for the holder. So, FICO and Vantage scores are stricter and they're designed specifically for housing. Uh, they're often lower than the applicant believes because of the strictness.
Kevin:Yeah. So, Stacie and I have been running our own credit reports for over 15 years now. When we first started, we were members of our local apartment association and we had a link through them that we could use to run credit reports. Another business bought out that linked company and somehow we landed upon Tenant Alert. And where we are not ones for change, but this was one of the best business transitions we made as landlords. Here's what we love about using TenantAlert. Their reports are instant. We can pay for the reports ourselves or have the applicant pay by sending them a link to pay and then we get the report. They have all reports available to add on to our general credit report. For example, we'd like to add on nationwide criminal and eviction searches. We can integrate the report into our application online and our website. They include bad check analysis and identity red flags, which most credit agencies do not offer. You can have up to four applicants on one order. I believe with a discount for the additional applicants. They provide a scoring system based on all the items in the report, which tells you if the applicant is financially a safe bet for you. We love this part. Their reports are easy to read and formulated with summaries to make it quick to look at monthly debt, and determine if their income to debt ratio is too high to cover your asking rent. And they offer a lease guarantee insurance policy you can purchase. The minimum cost is very reasonable.
Stacie:Yeah, the thing is, TenantAlert was created just for landlords. And their prices are very reasonable. I think we pay$17 for the base report. And their customer service is really easy to contact with any questions or concerns. They also offer reports for employees. So if you're looking to hire a manager to work one of your multifamily complexes, you can use their employee background service. There are many more services offered from online applications to document storage. And we often have free offers to use other sources to process credit reports, but we like the way TenantAlert is set up to order and access reports. But if you're a member of a rental association and they offer a couple of free credit reports with their membership en go for it. Most landlord software like TurboTenant offer options for tenants to complete an application online, pay for the credit report and have the info sent directly to you as well. TenantAlert has a PDF on all the services they offer. So we're going to link that and links to register for a free account in the show notes.
Kevin:And we'll also go ahead and link TurboTenant as well so you can check them out. So now that we have talked about the credit report and all that that entails, let's talk a little about what information you need to make sure is on your tenant application so that you can collect the proper information and compare it to the credit report. You'll need the prospective tenant's name, address, birth date, driver's license number, and social security number or ITIN, which is Individual Taxpayer Identification Number. Often you'll be able to collect the last three addresses of the prospect which allows you to check for accuracy on the credit report. There should also be places for them to enter if they receive or pay any judgments, like to another landlord or child support, as well as a place for them to enter any criminal issues as well. There should be a place for the applicant to consent to all background checks you complete, including ordering the credit report. The application is also the place for applicants to authorize you to run a credit report. If you are charging an application fee, you might also want to include a page for a receipt of that payment received and what it will cover. And I believe, not 100 percent sure, but I think it is a law that if the tenant wants a copy of their credit report, you have to provide that to them regardless of who paid.
Stacie:I know in California we have to provide them a copy if they ask for it, but I, I'm not sure about other states though.
Kevin:Okay. Well, I do know that if you deny renting to someone because of negative information in a credit report, or you charge someone a higher rent because of such information, you must give the prospective tenant the name and address of the agency that reported the negative information or provide them with the report so they can see why you came to that conclusion. This is a requirement of the Federal Fair Credit Reporting Act. You must also tell the person that he has a right to obtain a copy of the file from the agency that reported the negative information or provide them with by requesting it within 60 days of being told that your rejection was based on the individual's credit report. The Federal Trade Commission's website offers helpful tips on how landlords can use consumer reports. We'll link them in the show notes so you can read them over. And keep in mind it is illegal to charge a credit check fee if you do not use it for the stated purpose and pocket the money instead. You have to return any credit check fees you don't use for that purpose, so that's why we only process applications one at a time. Be sure prospective tenants know the amount and purpose of a credit check fee and understand that this fee is not a holding deposit and does not guarantee the rental unit.
Stacie:So let me clarify really quickly, an application fee, at least in the state of California, you have to define how much of that entire fee is going to what. So we'll state that X amount of dollars goes to the credit screening fee and the, the rest of it is a fee that we charge for processing the application. So that is what Kevin is talking about when he says not processing all the applications at one time because if you're going to take the first person it you have to return all the funds that you took for processing of the other applicants that were not accepted. All right, we're almost done and then we're gonna wrap this up. I want to remind everyone about discrimination and legal issues that come with pulling credit reports You are legally free to check tenant credit reports and use the information when selecting tenants as long as you don't illegally discriminate in doing so. For example, if you only request credit reports from certain tenants or by arbitrarily setting tougher standards such as a stellar credit record for renting to a tenant who was a member of a racial or ethnic minority or other protected class. You can't do that. Also federal law known as the Disposal Rule requires you to keep only needed information from a tenant's credit report and discard the rest once your evaluation is completed. And the last thing we want to remind you of is having your criteria and standards set and written for all to access. And this goes back to having solid standard operating procedures like we discussed in episode 6. Set your acceptance criteria so no one can come back and claim discrimination or say you favored someone else's application over their own. You must be able to quantitatively justify why you pick one application over another, which is also why we suggest you follow the rule of first completed application received is processed and any other apps that come in following have to wait. All right, so that is our show for today. We covered a little bit more than just how to read a credit report, but you know us, we get a little bit chatty. Thank you so much for tuning in and listening to all we have to say. We are beyond grateful that you take the time out of your busy day to listen. If you love what you hear, would you do us a huge favor and leave us a kind review so that we can continue to reach other rental property owners? We really need other listeners to know how our podcast has helped you and what you love about listening to us each week. You can find a link in the show notes for your review. And while you're at it, would you also follow or subscribe on your favorite podcast platform? Your downloads each week allow us to grow and reach other rental property investors. And lastly, we would love to connect with you. We have a great newsletter, it's free, and it has all kinds of tips and articles for rental property owners that you can sign up for. We will link it in the show notes along with links to our private Facebook group and social media sites. And until next time. You've got this, landlords.
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