To assess a tenant’s affordability, investors and landlords determine the rent-to-income ratio by calculating the monthly rent as a percentage of the applicant’s income. The industry standard is a maximum of 30% of gross income going towards rent.
According to HUD, tenants who exceed this 30% threshold are considered to have a high housing cost burden and may struggle to pay for other necessities such as food, clothing, medical care, and transportation.
If an applicant’s income is insufficient to comfortably pay for rent, landlords may require additional measures such as a larger security deposit, multiple months’ rent paid in advance, or a co-signer before moving forward with the tenancy.
How to Calculate the Rent-to-Income Ratio
To calculate the rent-to-income ratio, follow these steps:
- Obtain the applicant’s gross annual income.
- Divide the annual income by 12 to obtain the monthly income.
- Multiply the monthly income by 0.3 to find the maximum amount that should be spent on rent.
- Compare the result to the monthly rent amount to determine if the applicant qualifies based on the rent-to-income ratio of 30%.
For example, if the applicant earns an annual salary of $75,000, the monthly income would be $6,250 ($75,000 divided by 12). The maximum amount that should be spent on rent would be $1,875 ($6,250 multiplied by 0.3). In this case, the monthly rent of $1,800 is lower than the calculated maximum, indicating that the applicant would qualify based on the rent-to-income ratio.
How to Determine the Desired Income Level for Tenants
To determine required income for tenants based on the rent-to-income ratio, follow these steps:
- Multiply the monthly rent by 3.
- The result will give you the minimum monthly gross income required for the tenant to afford the rent payment.
For example, if the monthly rent is $1,800 and you require tenants to earn three times as much as the rent payment, the minimum monthly gross income would be $5,400 ($1,800 multiplied by 3).
It’s important to keep in mind that while the rent-to-income ratio is a useful metric, there are other factors that should be considered when making investment property decisions.
What is the Debt-to-Income Ratio?
The debt-to-income ratio (DTI) is an important metric to consider when evaluating potential tenants for your rental property. It is the same metric that mortgage lenders use to assess homebuyers’ ability to repay their loans.
DTI measures the proportion of a person’s income that goes towards paying off debts. If an applicant has little debt, they can afford to allocate a higher portion of their income towards rent, potentially up to 40% or 50%. On the other hand, if an applicant’s DTI is high, typically 50% or more, it’s likely that they will have difficulty affording rent and the rent-to-income ratio should be kept lower, around 30% or less.
In short, the debt-to-income ratio is a tool used to assess a person’s financial health and ability to repay debts, including rent.
What is a good rent-to-income ratio?
The 30% rent-to-income ratio is widely used in the rental industry, but it’s not a hard-and-fast rule. This standard was established by Congress in 1981 as a way to limit rent increases in public housing, and since then, it’s been widely adopted by investors. However, the 30% figure may not be applicable in all cases, especially in cities with high housing costs. For example, in expensive cities like San Francisco, it’s common for renters to spend up to 50% of their monthly income on rent, which is significantly higher than the 30% standard.
So while the 30% rent-to-income ratio is a useful benchmark, it’s important to consider each individual case and whether this ratio makes sense for that specific situation.
How to get Income InformationÂ
Many landlords request proof of income from their applicants. You can also find income information through a third party tenant screening service. These services not only give you access to the applicant’s credit report through a credit check, but they also provide a background check. The background check not only reveals any criminal activity, but also provides information on any past evictions the applicant may have had.
ScreenRenters’ $39 tenant screening includes the Income Insights report, which provides valuable information to landlords. This report gives landlords:
- An evaluation of whether the applicant’s credit behavior matches their self-reported income.
- An estimate of the difference between the applicant’s self-reported income and the Income Insights estimate.
- A suggestion on whether to ask for additional proof of income from the applicant, such as a recent paystub.
