One of the important functions of real estate management is for landlords to determine whether a new tenant will pay the rent on time is to run a credit check.
A common question landlords often ask is what is considered good credit and if an applicant does not have a perfect credit score, but has a high income. Can they be considered favorably as a tenant?
What is a Good Credit Score?
When you get applications and run a credit report on the potential tenant, anything under 600 is a poor score and a score of under five hundred is very poor.
A credit score of between six and seven hundred is an average score. A score of over seven hundred is considered good and everything else being equal, it’s a sign that the prospective tenant is financially responsible.
What to Look Out For
If a prospective tenant has a credit score of around five fifty, before declining their application because of the one credit score that doesn't meet your real estate management company’s requirements, find out the reason for the poor score.
At times people are not behind on payments but they have really old credit lines which are still open. The individuals may be of good standing and may not have made a late payment.
Rather than having a real estate management policy which declines an application based on the credit score, examine the applicant’s income, monthly debt and look at the big picture. You can also ask an applicant with a bad credit score to submit a one-page document explaining why they have bad credit and proof to show that any dues have been paid.
Steps to Conducting a Credit Check
It is important for landlords and real estate management companies to follow the right procedure to pull someone else's credit report. Here are the steps to follow:
Step 1: Learn how to interpret a credit report and credit score before you start obtaining them so you know bad credit when you see it.
Set a minimum credit score or other standards that will help you decide if attendance credit is acceptable.
Step 2: Get written permission from the applicant before doing the credit check and have them sign a form, which you should be added to the tenant’s file.
Step 3: Record the full name and address of the tenant so you can identify them to credit reporting agencies.
Step 4: Request reports from two or three major credit reporting agencies to ensure you have all of the information you need.
Step 5: Take proactive steps to protect sensitive personal and financial information about prospective tenants by keeping records in a locked filing cabinet and shredding documents you no longer need.
Step 6: Look into screening services that provide even more background information on your prospective tenants such as criminal background checks or consider a package deal to save money.
There are five categories of information that will influence your prospective tenant’s credit score.
The most important factor and one which weighs heavily on credit score is the payment history. This is the history of paying back loans and other debts such as credit card payment, car payments, student loans and others. Tenants who pay on time will have a high credit score, while those who have a track record of habitually late or missed payments will have a poor score.
This metric is the amount of credit owed or utilisation ratio. Let’s assume your prospective tenant has a few credit cards. If they use only a small portion of their credit limit then it will help their credit score, because it shows they are living well within their means.
On the other hand, if your prospective tenants are close to maximising their cards, it will reflect on their credit score. While it hampers their ability to draw any more credit limit, it lowers their balance relative to their credit limit.
Length of Credit History
This is the amount of time your tenant has had some form of credit and will probably date back to the first loan they obtained or the first credit card they were approved for.
This score gets affected when older credit accounts get closed down as it shortens the length of an individual’s credit history. This has the potential to hurt your applicant’s credit history.
Types of Credit Used
This is a lesser factor and can include debt such as a student loan, personal loans car loan or loans for other purposes. A prospective tenant who has only one credit card will be in a better position to manage their debts and accordingly have a better credit score.
Another factor which is considered important in computing a credit score is the payment history which reveals how well the prospective tenant has repaid the money they have borrowed over time. The reason for this is quite obvious as it demonstrates whether the prospective tenant has the disciple and financial ability make payments and reduce debts, in-particular credit card debt.
Why Credit Scores Are Not Perfect
Credit scores rely on accurate data which isn’t always available and any computations made using data which has gaps in it is flawed and inaccurate.
Banks are sometimes at fault and their systems are not always reliable and there have been several reports in the national press affirming the errors banks make and the problems they have in maintaining data integrity.
Experienced credit managers can pick up irregularities in credit scoring straightaway, however, do not have the time or inclination to seek an explanation from the individual on the reason for these.
When reviewing the credit history of prospective tenants, what landlords and real estate management companies need to look for is a pattern of financial responsibility. You want your prospective tenant to have a history of prudent or conservative spending.
Avoid rental applicants who seem to be using excessive credit and are living beyond their means. If they move into your rental property and experience even a temporary loss of income due to illness or a job situation, the landlord may be the one with an unexpected income loss as a result.