Finding reliable residents is one of the hardest parts of being a rental property owner. If you own an investment property and you’re looking to get it rented quickly to avoid vacancies, you may decide to accept a resident who doesn’t have the best financial credentials, including a low credit score. Here's a look at the process of evaluating an applicant’s credit and whether it makes sense to rent to someone with a low score.
How to Evaluate a Credit Score
Before you begin your search for residents, you should make sure you have a system in place to screen applicants, including a way to run a credit check.
Working with a real estate agent or a management company can help you with this procedure because they will likely have a screening system in place to process applications. But, if you want to do it yourself, there's a variety of software you can buy to run a credit check.
However, they aren’t free, and you'll have to pay a monthly or annual fee to use them, which may not make sense unless you have a large real estate portfolio already.
The next thing you need to know is how to analyze a credit report. The four main items of interest shown on a credit report are:
This includes the person’s legal name, address, place of employment, and so on. This section shouldn’t be of much importance to you as a rental property owner unless the information on their report doesn’t match the info on their application.
This shows the applicant's financial history, including how many tradelines and how much debt the person has. Tradelines include credit cards, credit lines, loans, mortgages, etc. A credit report will also show how much of this credit the applicant has used and how much money they still owe. Typically, if an applicant owes more than 30% of their total credit to lenders, it means they may be overleveraged and it will impact their credit score.
This shows how many other times the applicant has had a credit report pulled in the past two years. This shouldn’t be a big concern unless the person has a high number of recent credit inquiries. Statistically, those with more than 6 credit inquiries in a short period are more likely to file for bankruptcy.
Public records will show any judgments the applicant has been subject to that relate to their finances. This includes things like bankruptcies, liens, foreclosures, repossessions, etc. This is probably the most important section for a rental property owner to pay attention to because it will give you the best idea of the resident's true financial habits and obligations.
Credit bureaus will compile all this information and rate the person’s creditworthiness in the form of a score that ranges from 300 to 800. Many rental property owners and financial institutions use a 680 credit score as the minimum needed to be considered as a resident, but this can vary depending on several other factors. It’s up to your discretion whether you’re willing to accept residents with a lower score, or if you want to raise the requirement to protect yourself from risks.
Should You Rent to Someone with Low Credit?
While credit scores can be a good way to judge an applicant’s general financial profile, it’s not a perfect system and there are reasons why you may decide to accept someone with a lower score. That’s why it’s important to learn how to read a credit report and learn to spot what's an honest mistake and what's a red flag.
For example, an applicant may have gone through a major life situation like a bankruptcy or divorce that hurt their credit, but they are otherwise financially stable and responsible. If they have shown improvement and are getting back on the right path, you may decide to rent to that applicant over someone who has a better score but has several recent delinquencies. Especially if they can get a reference letter from a past rental property owner vouching for their ability to repay.
Or if you know the applicant personally and are confident about their character and ability to repay, this may also be a reason to overlook a bad credit score. However, you should still be careful and not be too trusting, otherwise, you could end up losing money and damaging a relationship if your assumptions are incorrect.
In general, if you are looking to minimize your risk and aren’t in a rush to get your unit filled, you should stick to applicants with good credit. But also understand a good FICO score doesn’t automatically make you a good resident and vice versa.
Sometimes applicants with the lowest scores can be the best residents because they know if they screw up again, they may not have anywhere else to turn. That’s why it’s important to look at the renter’s entire financial profile, including their income, savings, references, and any other information you can compile to get a more holistic picture of their situation.
If you're new to owning an investment property and aren’t confident in your ability to accurately assess a resident’s credentials, hiring a management company can help. They will have the knowledge and experience you need to assess the risk of each applicant and decide what makes the most sense for your entire portfolio.