Verifying a prospective tenant’s proof of income is one of the most important steps a landlord can take in determining whether a prospective tenant can afford the rental unit and pay the rent on time.
Asking for proof of income also helps verify that applicants have the job they say they do, and it helps strengthen your argument if you have to ask the tenant to have a co-signer on the lease.
15 ways to verify an applicant’s income
1. Monthly bank statements
Pro: Bank statements provide current information and are also tax adjusted.
Con: A tenant may feel that sharing these documents is intrusive. Also, if they’re self-employed, and they have non-traditional income, their statements may not give a completely accurate picture.
2. W-2 income statement
This standard document provides proof of income the government uses to verify income for tax purposes.
Pro: This document is produced by an employer and is very reliable.
Con: These statements don’t always give an up-to-date picture since they do not account for raises or promotions.
3. Recent pay stubs
Tenants usually get this document every pay period, and it shows exactly how much a tenant makes after their taxes are deducted..
Pro: It’s current and should be easy for a tenant to produce.
Con: You may want to verify the document with the employer.
4. Self-employment income and related tax documents
The IRS Form 1099 is the document used for people who are self-employed.
Pro: This tax document is easily verified.
Con: A self-employed person could have multiple 1099s, and you cannot necessarily verify if their work, and therefore their income, will remain steady throughout the year.
5. Federal tax returns
The IRS 1040 (Individual Income Tax Return) is probably one of the best ways to verify income since it’s the most comprehensive. It is a complete document, whereas the potential tenant might not remember all sources of income.
Pro: Tax returns never overstate someone’s income, and it’s a legally-binding document.
Con: It may not be a completely current representation of how much a tenant is making.
6. Letter from employer
This is usually easy for tenants to get. And if the employer gives a reference to the tenant’s work ethic you have increased your comfort level.
Pro: The letter can provide current information and the employer could also give some qualitative feedback on the potential tenant.
Con: These letters can be easily forged––some tenants can open a Word document and add the company’s logo. Landlords, instead, can email directly with the employer or call the person who wrote the letter to confirm that they actually wrote it.
7. Social Security Statement
Pro: Social Security is government income that is very stable. It’s easily verified, consistent, and usually not taxed.
Con: Payments can be stopped if Congress changes distribution rules.
8. Unemployment statements
These statements are government documents and are generated by a state unemployment office.
Pro: The income is guaranteed by the government.
Con: Usually, unemployment income runs out at some point.
9. Annuity statements
An annuity is a contract between a person and an insurance company stipulating that, in exchange for a lump sum of cash, you are promised a steady stream of cash-flow.
Pro: It’s easily verifiable and is usually consistent.
Con: This money usually has an end date. You should read the annuity statement and see if there is a date of expiration.
10. Pension distribution statement
This statement on your tax return is called a 1099-R.
Pro: Usually, pensions are a great source of income and are consistent.
Con: It can be tough to differentiate monthly distributions versus annual distributions. Also, the distribution amount can be changed by the pension.
11. Workman’s compensation letter
This letter should be issued either by the insurance company or the court awarding the compensation.
Pro: It’s easily verifiable from numerous sources.
Con: This type of income typically lasts for a finite period of time. You should read the letter awarding the compensation carefully to see if there is an expiration date.
12. Severance statement
This is a document given to people who have been laid off. Severances are a one-time payment.
Pro: It usually entails a large cash deposit so the tenant can afford several months of rent upfront.
Con: This is usually a one-time influx of cash, which you can’t count on for ongoing rent.
13. Proof of bonus/incentive payments
If your tenant has commission-based income––if they’re a salesperson or real estate agent, for instance––they may receive bonuses and incentives.
Pro: Commission-only tenants can have great income.
Con: It’s very hard to prove that this income is reliable and on-going.
14. Proof of interest and dividend income
These sources of income can easily be found on tax returns or brokerage statements. Look for a 1099-INT and 1099-DIV documents on the prospective tenant’s tax return.
Pro: It’s very reliable income.
Con: Usually, this income not enough to make a material difference.
15. Court-ordered awards letter
This is a document produced by the court system showing a mandated payment.
Pro: These payments are court-ordered mandates.
Con: The court order can be appealed or at least stalled for a significant amount of time.
How to evaluate income
1. Rent-to-income ratio
The most commonly accepted way of qualifying an applicant, from a financial perspective, is to calculate their Rent-to-Income, or RTI, ratio.
The industry standard is that a tenant’s total monthly household income be at least two to three times the monthly rent.
For example, if the monthly rent is $1,000, then the household must make between $2,000 to $3,000 in documented income per month.
2. Rent coverage ratio
An alternative and more detailed way to tell if an applicant is qualified financially is to calculate the “rent coverage ratio.” Here is how calculate rent coverage, using an example:
Verified monthly after-tax (net) income: $3,800
- Rent: $1,800
- Utilities: $200
- Cable: $120
- Cellphone: $100
- Car payment and insurance: $400
- tenant’s insurance: $150
- Groceries: $150 / per person
Total Expenses: $2,920
Rent Coverage Ratio: After-tax income of $3,800 / Total Expenses of $2,920 = 1.3
This means that for every $1 in expenses this tenant has $1.30 in cash flow to cover the expense. That’s a good, healthy margin. Consider keeping the minimum rent coverage ratio at 1.30 or higher.
No matter how you choose to evaluate and verify an applicant’s rental income, make sure you take it into account when choosing a tenant for your property.