Whether or not a prospective tenant can afford to live at your property and pay rent on time is the single most important consideration a landlord makes screening applicants. The stakes are way too high with the costs of eviction if the person is eventually unable to pay rent, making it the most important qualification landlords screen for with tenant applicants.
Landlords need to know what constitutes proof of income, the pros and cons of each type of evidence presented, and know whether the ratio of income to rent seems realistic for them to be able to afford it.
Most renters simply aren’t aware of how much rent they can realistically afford. Its not that they have any malicious intent. They simply haven’t taken a hard look at their net income after expenses, the effect of debt on their disposable income, and tend to overestimate how far their income will actually go each month.
It’s up to the landlord to verify the facts of their income as a hard-cold reality check on any prospective tenant or you can very easily be stuck with their misjudgments at your cost! Lack of cash is the number one cause of eviction – a very expensive and emotionally draining experience that is the worst part of land lording every effort should be made during the tenant screening process to avoid.
Landlords need to ask every prospective tenant for proof of income, which can take many legitimate forms but with each having certain advantages or limitations that need to be understood if it is actually “Proof” that they will be able to keep their obligations before handing over the keys.
1) Pay Stubs
Pay stubs or a W-2 Income Statement is the primary proof of income for salaried workers. Most W-2 salaried workers are paid twice a month.
Pay stubs are the single most reliable proof of income because they not only show the person’s full name, employer and current contact address, but it also shows their gross income and how frequently they get paid. They are usually easy for the person to find with little effort and most importantly, are current.
The tenant application should make clear proof of income must be provided at the interview, and any specifics like how many months of pay stubs are required to expedite the application to enable the landlord to make a full and accurate assessment of their income history. Most applicants don’t want their pay stubs to be left with the landlord for tax reasons, so make a copy with your smart phone or photocopy machine to be able to later verify the information presented.
Verifying the information presented on the pay stub is the next important step because fake pay stubs can easily be obtained on the internet for exactly this use. Happens all the time!
First, make a quick search on the internet to see if the company name is legitimate and for further contact information like a telephone number. Call the company and explain you have received a pay stub from a prospective tenant you are screening, are they an employee there?
You may or may not be able to get more information over the phone other than if they are employed, because human resource departments advise most people not to give out any more information than that to unknown people calling for information for fear of defamation of character lawsuits.
Keep in mind however, that self-employed people and independent contractors don’t have pay stubs and will have to show other types of documents as proof of income.
2) 1099 Miscellaneous Income Form
This is the tax document self-employed people and contractors use. Because it’s a tax document it’s a relatively safe statement of income so long as it can be corroborated with other sources.
The disadvantages of relying solely upon 1099 Miscellaneous Income forms is that they tend to be spread out over several documents if the person has more than one employer, and they reflect only a single year’s income which may be as much as a year or more old at the time they are presented. They don’t make it clear what a person’s monthly salary is and rent is usually due on a monthly basis.
Just because a self-employed person was able to earn that income a year ago doesn’t guarantee they will be able to do so consistently going forward. Steadiness of income is many freelancer’s Achilles heel compared to a salaried worker, so more than a single year of 1099s should be requested.
3) Tax Returns
Tax returns can be another way self-employed people or business owners can establish income. They have the great advantage that people don’t overstate their income. If this is presented as proof of income, at least a couple years of returns should be requested – the more the better for an in-depth look at their financial history.
Tax returns can give landlords a more comprehensive look at an applicant’s finances, but tax returns are more difficult for prospective tenants to share because of the greater level of insight into a person’s privacy that entails. The great American wit Will Rogers once said back in the 1920s just after the IRS and income tax was created that, “This legislation has turned more otherwise honest and law-abiding citizens into LIARS than any legislation in history!”
Understand many people may be reluctant to present their IRS Tax returns for a wide range of reasons.
4) Bank Statement
Bank statements are an excellent way to get supporting information to back up pay stubs, miscellaneous income statements, or tax returns. They can show a person’s cash reserves to be able to cover any emergencies, and give a better sense of how their monthly cash flow works.
Bank statements can support any other financial information presented with giving greater depth of insight into how their cash flow works. Are they making large loan payments that diminish their disposable income, or paying overdraft expenses which may reflect a lack of focus on their financial affairs?
Ideally, a landlord wants to see six months cash reserves to cover unexpected expenses. This all helps you verify the information provided and their ability to pay rent. If they bristle at providing a bank statement, that’s a red flag the landlord should take note of.
5) Letter from Employer
A letter from the tenant’s employer is usually relatively easy for the applicant to obtain. If the employer also includes any comments on their work ethic that can be another plus screening the applicant. A big advantage of this approach is that it is current.
However, a big disadvantage without further checking is that a letter like this can easily be forged. Best to follow up with a call to the person who wrote it and thank them for providing the reference to confirm that it’s real. Another disadvantage is that this may take time for the applicant to obtain slowing the screening process.
6) Social Security Statement
This is a government issued statement which shows a person’s income from Social Security or disability they are receiving. It’s most frequently used by retirees to show proof of income.
Because Social Security or disability payments are usually low, its best to use these statements in conjunction with bank account statements to get a truer picture of a person’s financial resources and ability to pay rent over an extended period of time. They should have several months of cash reserves to meet any unexpected costs and still pay rent.
These are the six most common forms of providing proof of income – pay stubs, 1099 Miscellaneous Income Form, tax returns, bank statement, letter from their employer and Social Security Statements. However, under certain circumstances other forms of proof may be provided.
7 Court-Ordered Award Letter
A court-ordered agreement is a legal document specifying a party has been ordered to pay another party. Child support, spousal alimony as well as payouts from a trust or lawsuit are some of the most common types of court-ordered payment letters.
A court-ordered agreement shows the source of the potential tenant’s income, the amount and frequency with which the payments are made. For example, one parent may be ordered to pay child support at the rate of $2,000 a month or $24,000 a year.
The tenant applicant will usually have a copy of this letter in their files, or can obtain one from the court clerk’s office where the ruling took place. See if the payment is monthly or a single lump sum payment. If it’s a lump sum payment, important to ask for a bank statement to see how much is left.
8) Proof of Commission Sales Payments
Commission-only tenants can have good incomes like real estate agents or mortgage brokers. They should be able to provide statements of their income from commissions.
Problem is, this may or may not be reliable income.
So while these statements can be very helpful in establishing recent income levels, it should be viewed together with other statements for a more complete picture of the period of time over which income has been earned this way – which can have its ups and downs.
For example, they may be doing well now. But how did they do during the last recession? By how much did their income drop?
9) Workman’s Compensation Letter
If a person has been injured on the job and is receiving workman’s compensation, they should be able to provide a letter from the insurance company paying them. Keep in mind that these payments usually have a termination date and be sure to find out when that is.
10) Annuity Statement
An annuity is a form of income where a person pays a large up-front cash payment to receive a steady stream of payment over a period of time. Annuity statements can be easy to verify, but keep in mind that annuities usually have a termination date so be sure to check to see when the annuity expires.
11) Interest and Dividend Income
This can easily be provided with a 1099-INT and a 1099-DIV tax return or a brokerage statement. This can be a reliable source of income.
12) Pension Distribution Statement
This statement can be provided with a 1099-R tax return form. It can be a good source of income that is consistent. However, it is reported with this form as an annual amount that is not clear if it is paid annually or in monthly stipends.
13) Unemployment Insurance Payment Statement
If the prospective tenant is receiving unemployment benefits, they can provide payment documents from their state unemployment office. This is a guaranteed income from the state, but it will run out at a certain point that needs to be determined.
This should be supported by additional records likes their bank statement so you see what type of cash reserves they have when the unemployment insurance runs out, and what efforts they are making and chances they have of finding employment. Wishing and hoping alone six months from now won’t pay the rent
14) Severance Statement
This is a document if someone is laid off through no fault of their own which will often involve a large payment of cash so a tenant may be able afford several months rent in advance. Keep in mind this is usually a one-time cash payment that cannot be relied upon for ongoing rent.
This should be accompanied by bank statements so you see what type of cash reserve and monthly expenses they have.
15) Profit and Loss Statement
This is a statement if the tenant is a business owner who can account for their income with a profit and loss statement they can obtain from their accountant or bookkeeper. Look to see if it was prepared by a certified CPA.
This can be useful to examine the applicant’s finances and trends in their business to determine solvency, but should also be supported by other documents like a bank statement or tax returns.
Income to Rent Calculation
After receiving proof of their monthly or annual income statements by one of the above 15 methods the next step is to qualify them by calculating their Rent-to-Income ratio or RTI.
Generally accepted standards in the housing market is that the rent should not exceed 30% of your tenant’s income. In other words, someone earning $6,000 a month should not be paying over $1,800 a month in rent to qualify. If rent is taking more than 30% of the renter’s income, they may not be able to afford it for the duration of tenancy to afford this lifestyle.
Again, assume most renters simply are not aware of how much they can realistically afford. As the landlord, you have to do this reality check qualifying them, because they may well think they can afford more than they actually can. If they get it wrong and you don’t qualify them, you may end up having to evict them if rent goes unpaid which is one of the most expensive mistakes a landlord can make.
Here’s an online Rent-to-Income Ratio Calculator to help you determine if they can afford your rental. It’s essential to make proof of income part of your tenant application process to determine – whether the prospective tenant knows it or not – if they can actually afford your rental or not.
At Fast Eviction Service, help on any of the issues discussed in this article is simply a click or phone call away. Email email@example.com or call our office at (800) 686-8686 to discuss your questions for a free evaluation of your case.
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