Tenant Credit Screenings

Tenant selection is the most important decision a landlord can make for his business. Selecting the right tenant, a quality tenant, is important to ensure timely rents and protection of the investment property. Tenant screenings are the risk protection measures required for an informed tenant selection decision. Credit screenings utilize credit reports and credit scores to identify and analyze the risks of potential tenant rent defaults. The ability and willingness to satisfactorily meet debt obligations as shown by the applicant’s credit history is a decisioning factor for many landlords in tenant selection.

A landlord’s due diligence is required to determine the legal compliances and regulatory requirements governing the location of the rental property. Legal compliances require consumer notification and consent before a consumer report can be obtained for screening. In some localities landlords are restricted or prohibited in the use of credit screenings and credit scores for tenant screenings.

Financial evaluation of tenant risk is usually based on analysis of the applicant’s credit report and/or credit score as allowed by statute and ordinance. The credit report provides details of credit usage, payment history, and debt exposure. A credit score is a summary numerical assessment of risk compiled from information in the credit report. A credit report and a credit score are two separate credit screenings. While a credit report can be a primary credit screening tool, some landlords choose to use both an applicant’s credit report and credit score to fully evaluate potential financial risk to their business. If a landlord chooses to utilize both credit report and credit score screenings as his rental standards for qualification, then all applicants must be evaluated using both types of screenings.

Credit Reports

Credit reports are part of the broader category of consumer reports as regulated by the federal Fair Credit Reporting Act (FCRA). The term ‘consumer report’ as used in the FCRA means any written, oral, or other communication about an individual’s personal credit worthiness, character, and general reputation. Requestors of credit reports must have permissible purpose as defined by the FCRA.

The three major national consumer credit reporting agencies (CRAs) are Experian, Equifax, and TransUnion. Each CRA is a separate entity with its own consumer credit data files, reporting format, and proprietary scoring models.

Credit reporting agencies do not make any credit granting decisions. Consumer credit data is collected by the CRAs from sources such as financial institutions, credit card companies, finance companies, retail merchants, and various other credit-reporting entities. Not all creditors report credit data to all three credit reporting agencies; therefore there may be differences in credit data if credit reports were to be obtained from all three CRAs. Data collection schedules may vary among each CRA but generally consumer credit files are updated monthly with data related to the type of credit used, outstanding account balances, and payment histories.

A credit report is a primary source of financial information about the applicant’s use of credit and credit management. Taken in context the credit report can provide a reasonable expectation of the applicant’s future credit usage and management. The credit report details debt obligations, debt load, payments history, and public records of liens, judgments, bankruptcies, evictions and collections.

A credit report provides a documented history of payment behaviors. This provides the landlord with a good indication of the applicant’s willingness and ability to consistently meet his debt obligations or, conversely the applicant’s inability to meet those obligations. Satisfactory payment history with more than one creditor demonstrates an ability to manage total debt obligations.

The credit report details the applicant’s trade lines historical and current records of payment activities, such as:

  • Creditor name, account number, and date opened.
  • Type of credit (installment or revolving).
  • Account holder (individual or joint).
  • Total amount of the loan, high credit limit, or highest balance.
  • Balance due.
  • Fixed monthly payments or minimum monthly payment.
  • Account status (open, inactive, closed, and paid).
  • Payment history.
  • New accounts.

Understanding the information on credit reports provides background for understanding credit scoring.

Credit Scores

While a credit score has oftentimes been regarded as a more objective screening and selection tool, the numerical score by itself has traditionally been a source of discussion regarding what constitutes a “good” number. However most landlords agree that a higher credit score is preferable if not predictive of a good tenant.

How a credit score is calculated is dependent upon the credit scoring model that is used. There are many different credit scoring models targeting various credit populations, industry applications, and specific credit products.

Each credit reporting agency generates its own scores by running the consumer’s credit data through a proprietary modeling process. Predictive variables could include, but are not limited to, prior credit performance, current level of debt, amount of time that credit has been in use, and new credit. Any characteristic or attribute that is prohibited by law for credit decisioning or that lacks predictive value would be excluded from scoring. This means that credit scoring cannot take into consideration race, color, religion, national origin, sex, marital status, receipt of public assistance, or the exercise of any consumer right by law. Age, occupation, sources of income, employment history, residence, interest rates on credit accounts or family support obligations (unless support obligations are a matter of adverse public records) cannot be used in calculating a credit score.

The scoring model summarizes the relevant available consumer credit data into a set of ordered categories that predict an outcome. The ordered set produces a numerical score which is a snapshot of estimated credit risk at a set date in time.

Scores statistically assess the consumer’s risk within the context of the total risk for the credit population being scored. In general, a model assesses the likelihood of the consumer’s propensity to default, generally to allow debt to become 90 days or more delinquent within a 24 month period following the analysis date.

While a model forecasts the probability of credit default, it is not necessarily a predictor of the level of risk or the magnitude of loss as a result of default. Landlords need to individually assess the amount of risk posed by the rental applicant in relation to the amount of risk the landlord is willing to absorb if the applicant is selected for tenancy and subsequently defaults.

A credit score serves as a general indicator of financial responsibility rather than an absolute measurement of credit risk. It is a predictive model of the individual’s ability to pay and to pay on time. It is not a guarantee that the individual will be a good tenant.

The question for many landlords is what number is considered a good credit score. Should there be a minimum credit score for qualification? A landlord can set his own standard in regard to credit score qualification requirements. As long as the landlord utilizes the same criteria for every applicant, the landlord can set a qualification for credit score. However each landlord must consider his own business necessity and local market conditions. For some landlords the minimum credit score that is acceptable is based for the most part on their rental property, the rental location and the rental property condition. A rental property that is distressed, either by location or by condition will not command the rents of higher end rentals and thus a lower minimum score would be appropriate for the rental market being served.

A credit score is not an absolute statement of credit risk nor does a credit score indicate financial strength or stability. However credit reports and credit scores when used in conjunction with other tenant screenings and risk reduction policies may help a landlord make a more informed tenant selection.

Credit reports and credit scores are the most commonly used tenant screenings to evaluate potential financial risk posed by an applicant. There are other options for credit screening such as services that provide rent recommendation models to evaluate credit risk. A rent recommendation is a report based on a software-based scoring model programmed with landlord specific credit risk criteria. The model uses a simple rules-based or a statistical based program to evaluate the applicant’s credit risk. Rather than a credit score, the decisioning model provides a credit recommendation for acceptance, acceptance with conditions, or decline based upon the applicant’s information and the scoring criteria as supplied by the landlord. A rent recommendation model does not provide direct access to the applicant’s credit report. The model performs the screening analysis and prepares a report as per the landlord’s specific standards. Some landlords prefer to use this type of credit screening as an objective third party review of the applicant’s credit data.

Credit reporting agencies may offer specialized proprietary services to landlords that provide industry specific renter risk scores or that incorporate tenant rent payment data into the credit report as part of the consumer’s credit profile.

Tenants have options as well to utilize rent reporting services to submit their rent payment history to credit reporting agencies. A landlord reviewing the credit report for an applicant using a rent reporting service may find a landlord listed as a trade line with associated payment history.

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