How to Interpret Your Tenant’s Credit Report
As a landlord, choosing the right tenants is the most important thing that you will do. Picking the right ones helps ensure (but can’t guarantee) that your tenants will pay rent on-time and that your tenants take care of your investment property. Ask any landlord who has experienced renting to awful tenants, and they likely didn’t properly screen the individuals before signing the lease.
Our Complete Guide to Tenant Screening covers all of the steps of a good process. An important part of the application process is obtaining and analyzing the tenant’s credit report. Our goal with this post is to help you understand how to interpret your tenant’s credit report so that you can use it to make an informed choice when selecting tenants.
WHAT IS A CREDIT REPORT?
Let’s start by looking at what a credit report is and why it is a helpful tool for screening tenants. The TransUnion credit reports that we provide to our landlords for tenant screening contain two important parts. The first piece is the prospective tenant’s credit score, and the second is the individual’s detailed payment history for things like credit cards, auto loans, student loans and mortgages.
Landlords require credit reports from tenants because it helps them see all of the other monthly payments the tenant is responsible for during the lease. When you rent your property to an individual, you are becoming a creditor (not dissimilar to making a loan to the individual). For the duration of the lease, the renter will owe you a monthly rent payment. If a renter’s other monthly obligations plus the rent amount (due to you) exceed the tenant’s income, sirens should start going off. If the tenant’s monthly payments plus rent are a low percentage of his or her income, then you can have greater comfort in the tenant’s ability to make payments.
The other reason all landlords should require credit reports is that it gives them an unedited view into how tenants have handled their financial obligations in the past. Unlike with stocks (where for legal reasons there must be the same, boring legal mumbo jumbo “past performance is no indication of future results”), we can confidently say that an individual’s past payment history is an excellent indicator of how he or she will handle payments in the future. If the individual has consistently paid his bills late, you can reasonably expect that the same will be true for your rent payments. And because you’re likely counting on that payment to make a mortgage payment, we recommend avoiding tenants with sketchy payment history.
SETTING STANDARDS FOR YOUR PROPERTY
Before we jump into explaining the sections on the credit report and how to interpret each one, it is important to emphasize that while the credit report contains a lot of useful, detailed information, you ultimately have to determine what standards must be met in order for a tenant to rent your property. The standards you set for your property will likely depend on the demand for your property (the higher demand, the pickier you can be) and your risk tolerance (being too picky can cause a vacancy and potential lost rent income, while being too lax can result in tenant who can’t/won’t pay rent).
To set standards for your property, there are three variable you’ll want to consider setting requirements for: credit score, frequency of late payments and outstanding debt (including the rent you’re expecting) relative to monthly income. These three variables are all related, but you may decide to put more emphasis on one more than the other based on your experiences. w
Now that we understand what the credit report is and the lens through which to look at it, let’s examine the two components, the credit score and the payment history section.
TRANSUNION CREDIT SCORE
The credit score that we provide for our landlords comes directly from TransUnion and is based on a proprietary algorithm developed by the credit bureau. The TransUnion TransRisk credit score is the number that appears at the top of a potential tenant’s credit report. The score exists on on a scale of 300 (lowest) up to 850 (highest possible score), and is meant to be a single number that summarizes an individual’s credit history.
Unfortunately the formula for determining the credit score is kept as secret as the special formula for Coca-Cola. While the calculation itself is not shared publicly, everyone agrees that the more financially responsible an individual is, the higher his or her score will be. We developed the chart below to help you easily decipher the meaning of your prospective tenant’s credit score.
Caution, do not stop reading here! Unfortunately many landlords put too much emphasis on the credit score alone. It’s easy to understand why, though. The credit score is a number, and it’s easy to look at our chart to understand where a number falls on the spectrum. The next section of the credit report contains the majority of the useful information. It is more subjective and requires some judgment calls, but this extra effort will pay off when you have great tenants who always pay rent on-time.
DETAILED CREDIT HISTORY
The second section of the credit report, the detailed credit history, is the most valuable part of the report for landlords when evaluating prospective tenants. This section of the report allows you to do two important things. First, you will be able to understand what other monthly payments the tenant is obligated to pay. Second, you will understand the tenant’s full payment history.
When considering whether to rent to someone, the most important question to ask yourself is, “is this person capable of paying the rent every month?” An individual’s income is an important part of this equation, but equally important is how much money the individual is obligated to pay for auto payments, student loans, credit cards, etc. To understand how much in payments a tenant is on the hook for each month, you will simply need to look into the details of the credit report. Within the credit report, there will be a separate block of information for each of the tenant’s financial obligations. Within this block will be a line item that shows monthly payment. On a piece of scratch paper (or in your head), we recommend tallying up these monthly obligations, adding the rent amount and comparing the total to the individual’s income.
Your next mission in analyzing tenants credit reports is understanding their payment history, and whether they frequently pay bills on-time. At Rentalutions, we make it easy to view this information by giving you a colored month-by-month breakdown of a tenant’s payment history. Months shaded green were paid on-time, yellow implies that the payment was late and red means that the payment was never made.
When looking at each of these sections (one for each debt obligation), you are expecting to see long stretches of payments that have been paid on-time. This can give you comfort, but not guarantee, that an individual is likely to pay rent on-time every month.
It’s worth noting that rent payments are not typically reported to the credit bureaus, so the tenant’s history paying rent will generally not appear on the credit report. At Rentalutions, we’re working to change this, but for now, you should always speak with tenants’ prior landlords to understand whether they paid rent on-time.
INTERPRETING YOUR TENANT’S CREDIT REPORT
When speaking with landlords about how to interpret a tenant’s credit report, we suggest thinking about the potential outcomes like a stoplight. The modern stoplight was developed in the 1860’s in London to help drivers easily navigate busy intersections. Just like a stoplight at a busy intersection, our diagram below is a framework for assessing a tenant’s credit report.
Certain credit reports will be so good (high credit score, good payment history, etc) that you can feel pretty confident about the tenant’s likelihood of paying rent on-time and you can quickly proceed to the other steps of the screening process.
On the other extreme, certain tenants will have such an ugly credit report, that you can immediately stop the screening process. These individuals likely have poor payment history and a lot of payment obligations relative to their incomes.
In the middle, the yellow part of the stoplight, are the tenants who still may be worth renting to, but require some additional questioning to understand the specifics of what happened. For example, a tenant may have lost his job in the recession of 2007-2009 and was unable to pay his bills. While this would have a negative impact on his credit report, he may have gotten a new job and has paid every bill on time since then. These are the gray area situations that require you to gather as much information as possible and ultimately make a judgment call based on what you know.
HOW TO OBTAIN A TENANT’S CREDIT REPORT
Obtaining a credit report for a prospective tenant used to be nearly impossible for individual landlords. For starters, anyone requesting another individual’s credit history had to be verified by the credit bureau as a legitimate business with good reasons for “pulling” reports. These businesses had to maintain proof that they obtained consent from the tenant and had to undergo annual business inspections (worse than being pulled aside for extra screening at the airport). After passing inspection, landlords only option was “pulling” credit reports by providing an individual’s social security number and driver’s license number. This “pull” resulted in a hard inquiry and negatively impacted the tenant’s credit score.
Fortunately for you, the process is a lot simpler nowadays. Rather than taking tenant’s personal information and manually entering this into a system, tenants log in to their Rentalutions account to authorize who has access to their credit details. This process results in a “soft” inquiry, which does not negatively impact their credit score.
You can easily get started screening tenants by using our online rental applications and credit reports.
USING A CREDIT REPORT PROVIDED BY THE TENANT
In several large cities, such as Chicago, New York and San Francisco, the rental market is smoking hot nowadays. Tenants in these markets (and several others) are accustomed to applying for multiple properties before ultimately being selected by a landlord. In these hot markets, tenants will often obtain their own credit report to present to every property they are applying for. This ultimately saves money for the tenant by minimizing application fees. I myself have been a tenant in this situation, so I can sympathize with these renters.
As a landlord, though, you still need to protect yourself from potential risks. If a renter wants to use a credit report that he or she has already paid for (as part of another rental application), we recommend allowing this so long as the renter could not have doctored or changed the report. For example, at Rentalutions, we allow renters to pay for a credit report/background check and share the results with other landlords whose properties they are applying for. We keep the renters credit report information in our system (securely encrypted) for 30 days after the initial application. If the renter wishes to share these reports, he can invite the other landlords to view the reports inside our system. There’s no chance that he could have performed any Photoshop magic because the reports were never in his hands.
There are two final points that are important to keep in mind when thinking about your potential tenant’s credit report. First, it is worth mentioning an overlooked benefit to requiring a credit report from a potential tenant. The benefit that most landlords don’t consider is that the credit report helps to verify a potential tenant’s identity. When authorizing the credit report the tenant must provide personal information and answer several questions to validate that he is who he says he is. This can help you be confident that you know who you are renting to. While it is extremely uncommon, sometimes individuals will rent a property using an alias. If this occurs, it is a major red flag.
The last point to make on credit reports is the confidentiality of the information. The details of an individual’s credit report are extremely personal to him or her. When your potential tenant authorizes you to view these details, he or she is trusting that you will keep the information confidential and that you will only use it to judge whether he or she is qualified to rent your investment property.
Congratulations for making it all the way through this post. You are now equipped with the information needed to develop an informed opinion of prospective tenants based on their credit reports. Don’t forget, though, that a credit report is only one aspect of a thorough tenant screening process.