How to calculate your tenant’s rent to income ratio
Calculate your potential tenant's rent-to-income ratio to evaluate if they are financially able to afford your property's rent with RentSpree's free calculator.
When determining whether a potential tenant is financially able to rent your property, knowing how to calculate their rent to income ratio is critical. In this article, you’ll learn what constitutes a strong ratio, how to calculate this important metric on your own, and how to use our rent to income ratio calculator to check your work.
Why does rent to income ratio matter?
For landlords or listing agents seeking to find dependable tenants, considering the rent to income ratio during the rental application process is essential. In a nutshell, this ratio can help you make a more informed decision about whether or not an applicant earns enough money to consistently pay rent on time.
For example, if a tenant's rent to income ratio is excessively high, it may indicate that they are financially stretched which could increase the risk of late or missing payments. On the other hand, if the ratio is within a reasonable range, for example between 25-30%, it suggests that the tenant's income is sufficient to cover the rent comfortably and they’ll be less likely to have financial issues during the tenancy. By calculating an applicant’s rent to income ratio, in addition to other factors that will give you a clear picture of their financial state, you can identify qualified candidates most likely to pay their rent on time and in full every month.
How does rent to income ratio fit into your overall financial review?
While the rent-to-income ratio is a crucial component of the tenant screening process, it’s not the only metric you should use to evaluate an applicant’s candidacy. For a comprehensive financial overview, you need to collectively consider all of the following factors:
Credit score and history: An applicant’s credit score and history can provide detailed insight into their financial habits and reliability. If they have a good credit score and a positive payment history it indicates responsible financial behavior whereas a poor credit score suggests a history of financial mismanagement or difficulties in meeting financial obligations.
Employment verification: You’ll also want to confirm the applicant’s employment status and verify that they have a steady income. Someone who has a history of long-term jobs will be more reliable than someone who’s had frequent job changes or currently does not have a job. Keep in mind, however, that job status alone is not necessarily a reason to disqualify a candidate. An applicant who is unemployed may still be able to afford rent if they have other substantial financial resources or savings.
Rental history: Checking references from previous landlords allows you to verify rental history details such as dates of tenancy, rent amount, and payment consistency. It’s an opportunity to ask about an applicant’s behavior, including whether or not they respected the property, followed lease rules, and treated their neighbors well. When you contact references, you can also learn if the applicant made on-time payments and inquire if there were any potential red flags you should know about.
Debt-to-income ratio: This ratio compares the tenant's total monthly debt payments to their gross monthly income, so you can assess whether the tenant can afford the rent in addition to their other debts. A low debt-to-income ratio signifies that the tenant's debt is at a manageable level, making it more probable they will pay rent punctually. Conversely, a high debt-to-income ratio implies that the tenant might be financially stretched.
What is a good income to rent ratio?
According to industry standards, the suggested rent to income ratio is around 30% or less. This means tenants should ideally spend no more than 30% of their gross monthly income on rent. A 30% ratio is generally considered affordable, leaving sufficient income for other necessary expenses like utilities, groceries, transportation, and savings.
Plus, keeping the rent to income ratio within this limit helps tenants maintain a healthy balance between their housing costs and other financial obligations. For example, if a tenant has a gross monthly income of $5,000, they should look to pay rent amount up to $1,500.
It’s also important to take into account that much of the “ideal” rent to income ratio is dependent on where you live since major metropolitan areas may see much higher ratios, sometimes as high as 50%.
In the event that a renter’s rent to income ratio is higher than 30%, you can implement additional safeguards to mitigate potential risks. You can:
- Ask for an increased security deposit to help your renter keep additional funds in escrow in the event of non-payment
- Charge a monthly pet rent as an up-front pet deposit, reducing the rent due month to month
- Ask for a co-signer on the lease and use their income as additional consideration for the renter’s ratio
What types of income should you count?
To get an accurate picture of an applicant’s entire financial situation, you need to consider all sources of income. When you verify income for your rental applicant, take these factors into account:
Social Security benefits: These can be verified through an award letter from the Social Security Administration or by an applicant’s checking bank statements.
Alimony and child support payments: These funds can be verified through a court-ordered award letter.
Annuity or investment income: You should be able to verify dividends and payments from investment accounts through a statement from an applicant’s brokerage. Pay particular attention to and verify the expiration of payments to see if they will continue for the foreseeable future.
Pension or other retirement income: Verify pension or retirement income through a pension statement or through bank statements.
Bonus, commission, and incentive payments: Applicants should be able to provide proof of income from these sources but you may want to see more than two or three months of overall income in order to determine how steady their cash flow is over time.
Self-employment income: Freelancers and contractors may have income from a variety of sources and payments might not always follow a predictable schedule. Consider asking for several months’ worth of bank statements to ensure an applicant has the necessary funds to cover rent for an entire.
Income from worker’s compensation, insurance compensation, severance pay, or court-awarded compensation: These can be verified through documentation from the court or company making the payment.
While you can use any or a combination of these types of income to count toward your applicant’s income, you’ll want to consider how reliable this cash flow is regarding long-term compensation. For example, while Social Security or pension benefits tend to stay the same month after month, severance pay or a bonus payment may constitute a one-time payment. You’ll need to look for ongoing income rather than limiting yourself to an income assessment based on a single, non-repeatable event.
Calculating the rent to income ratio
There are typically three ways to calculate the rent to income ratio: the predetermined rent to income ratio, rent to income ratio multiplier, and property-based calculations.
Predetermined rent to income ratio
The predetermined rent-to-income ratio method involves using a fixed percentage to assess a tenant’s ability to afford the rent. This percentage is typically set based on industry standards or landlord preferences.
How it works
- Set the percentage: Determine the percentage of income you expect tenants to allocate toward rent. As mentioned above, a common standard is 30%.
- Calculate maximum rent: Multiply the tenant's gross monthly income by this percentage to find the maximum rent they can afford.
Example
Tenant's gross monthly income: $5,000
Predetermined percentage: 30%
Maximum rent = Gross monthly income × predetermined percentage
Maximum rent = 5,000 × 0.30 = 1,500
In this example, the tenant should ideally pay no more than $1,500 in rent.
Rent-to-income ratio multiplier
The rent-to-income ratio multiplier method involves setting a multiplier to calculate the minimum income required to afford the rent. This approach is often ideal if you need to quickly assess a tenant’s financial suitability.
How it works
- Determine the multiplier: Choose a multiplier based on your desired rent-to-income ratios. A common multiplier is 3, meaning the tenant’s income should be at least three times the monthly rent.
- Calculate required income: Multiply the monthly rent by the chosen multiplier to determine the minimum income needed.
Example
Monthly rent: $1,200
Multiplier: 3
Required income= Monthly rent × multiplier
Required income=1,200 × 3 = 3,600
In this example, the tenant needs a gross monthly income of at least $3,600 to afford the $1,200 rent.
Property-based calculations
The property-based calculations method takes into account the specific characteristics and costs associated with a particular property. This method is more tailored and considers the unique aspects of each rental.
How it works
- Analyze property costs: Assess all costs associated with the property, including maintenance, utilities, taxes, and insurance.
- Determine necessary income: Calculate the total monthly costs and apply a desired profit margin. Use this total to determine the minimum income a tenant should have to afford the rent comfortably.
Example:
Monthly property costs: $700 (including maintenance, utilities, taxes, and insurance)
Desired profit margin: 50%
Monthly rent: Property costs + profit margin
Monthly rent = 700+ (700×0.50) = 700 + 350 = 1,050
Next, determine the tenant’s required income using the predetermined rent-to-income ratio:
Predetermined percentage: 30%
Required income = Monthly rent ÷ predetermined percentage
Required income = 1,050 ÷ 0.30 = 3,500
In this example, a tenant needs a gross monthly income of at least $3,500 to afford the $1,050 rent, considering the specific costs and profit margin associated with the property.
If math is not your strong suit or you want to simplify the process of calculating rent to income ratios, the RentSpree calculator is here to help. Here you’ll be able to crunch the numbers and find the desired rent to income ratio for your rental property or rental applicant.
How can you encourage on-time rent payments?
Ensuring that tenants pay rent on time is crucial for maintaining cash flow and the financial health of your rental property. Here are some strategies to encourage timely payments:
Clear lease terms: Explicitly outline rent payment terms in the lease agreement, including due dates, acceptable payment methods, and late fees.
Open lines of communication: Clear communication can help foster trust, transparency, and accountability in the landlord-tenant relationship. Remind tenants of upcoming rent due dates and be open to discussing assistance or accommodations if a tenant experiences financial difficulties.
Automated payments: Streamline the rent payment process with an automatic payment option and monthly reminders sent to your renter’s email or phone. With online, automatic rent payments, you're much more likely to receive payments on time.
Consistent reminders: Send out additional reminders as needed, especially if the first of the month falls on a weekend or holiday. Let tenants know where and how they can pay their rent to ensure that it is recorded as an on-time payment.
Incentives for on-time payments: Consider offering small incentives for consistent on-time payments, such as a discount on the next month’s rent, a gift card, or credit bureau reporting.
Late fees: Implement and enforce a late fee policy. While this is more of a deterrent than an encouragement, it can motivate tenants to pay on time to avoid additional charges.
Calculating rent to income ratios with RentSpree
Evaluating financial data for your rental applicants can be time consuming, and so can chasing down tenants to pay rent on time every month. But conducting this due diligence ensures you’re getting all the information you need to make the best decision possible for your rental investments. With tools like RentSpree, you can simplify every aspect of the rental application and tenant evaluation process, and even manage the payment process once you’ve decided on your next tenant.
As you prepare for your next tenant, consider using RentSpree Rent Payment to:
- Collect one-time and recurring payments. Cover your bases across deposits, fees, and monthly rent.
- Put your tenants on a schedule. We’ll do the heavy lifting and let them know when a payment is due.
- Stay up to date. Get notified about processing payments and confirmed deposits.
- Get paid fast. Fast payouts in as little as 2 business days.
- Easily track all your payments. Maintain records for payments that happen inside and outside the platform.
Ready to learn how? Get started here.