Tenants with a Bad Credit Scores

Rehabbing bank foreclosures, a.k.a REO’s, for long term positive cash flow with little to no money down, will typically require investing in low to middle-low income neighborhoods.  When working in these neighborhoods, there will be times when the pool of tenants to choose from will all have bad credit along with several delinquencies on their credit report.  So how does the real estate investor, rehabber, and/or landlord choose a tenant under these circumstances?

Steady Employment

When credit scores are low and late payments take up the first three pages of the credit report; look for the tenant with a steady a job with at least a year of current employment.  The longer the tenant’s current employment, the better.  Steady predictable income shows that the person is capable of holding on to a job and most likely does want to deal with eviction headaches.  One tenant I have has been employed for over 17 years for a large transportation company and has never been more then 12 days late on her rent in the past 3 years.  This tenant’s credit score was 538 at the time of application.

Reputable Employer

Make sure the employment is with a reputable company and not the local home day center down the street.  It’s pretty easy to lie about the details of one’s income or length of employment when the employer is a small and unknown business that solely pays in cash.  Make sure the employer is established and not just someone’s car repair service in the back of a friend’s garage.  Remember, only select tenants with verifiable income (1 month of paycheck stubs) and always confirm their current employment.  Do not bend on this one.

Enough Income

Make sure the income can cover the tenant’s expenses.  Look at all of the tenant’s debts, well at least those that will most likely get paid such as the car note and make sure there is enough income there to cover monthly living expenses.  There is not a great rule of thumb here (such as when qualifying a mortgage applicant) so just make sure the debt to income ratio makes sense.  Ask for more clarification if it doesn’t.

Steady Rental History

Look at the past rental history of the potential tenant.  If the tenant has lived at 6 different addresses in the past 5 years then stay away.  Someone that has shown that they can stay at an address for 3 or more years at a time is more likely to have been paying their rent on time and will not cause you a sooner than expected turnover cost.  Also, a history of steady addresses of several years each indicates that they will at least pay their rent if nothing else when money is short.  Address history will be shown on the tenant report provided by most reputable tenant screening companies.

Recent Bankrupcy

Recently discharged bankruptcies can be a good thing if there is a steady rental history with verifiable income and steady employment.  After a bankruptcy, the person’s debt has been wiped out by the court and they have been given a fresh start in which they should be more capable of making their monthly housing payment.  The fresh bankruptcy also means that the tenant will have a hard time obtaining credit to run up and fall behind on again.

One Month’s Security Deposit

Finally, anyone capable of putting down one month’s rent as a security deposit is more likely to take better care of the property and is less likely to skip out on you in the middle of the night.  This shows that the tenant has some positive income and provides the landlord with a months cushion if the tenant falls behind on the rent.  Make sure to obey your state’s security deposit laws before touching this money.

Not everyone will be able to put down one month’s security deposit.  In these cases consider collecting a move-in fee instead of a reduced security deposit.  Move-in fees are non-refundable and are not governed by strict holding laws like security deposits are.  Even luxury apartment complexes are now collecting move-in fees instead of security deposits.

Automatic Withdrawal

Another sure-fire way to maximize the chances of collecting your rent is to make the tenant sign up for automatic withdrawal from their checking account every month.  If a tenant does not agree to this, just ask them if they are actually planning on paying the rent on time every month.  Most people will go out of there way to avoid overdraft fees on the checking accounts which makes it more likely you will be paid every month and on time.

The Goal is to be Flipping Houses not Flipping Tenants

It is possible to find quality tenants in low income neighborhoods as long as you understand what to look for during the screening process.  There are several factors on the tenant’s screening report that are red flags and those tenants should be avoided in most cases.  See the article, “3 Zero Tolerance Red Flags all Landlords should look for when Screening a Tenant” for more information.