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If you’re in the market to rent a house, your potential landlord or property management company will look at a couple of main factors to determine if you qualify. Most people know they check your credit score and credit history, but they aren’t aware of the rent-to-income ratio (slightly different than the debt-to-income ratio) and how it works.
Landlords and property managers want to make sure you can afford the property you are applying to rent. By finding out how much an applicant earns, property management companies and landlords can determine what percentage of a prospective tenant's household income will go to monthly rent, which is the rent-to-income ratio. Each landlord, and property management company may have a different percentage, however, at PGMG, our firm standard is 30%, meaning no more than 30% of a tenant's gross income should go to rent, so we will use that percentage in our examples.
What is a Rent-to-Income Ratio?
Your RTI is a comparison of your rent debt to your gross monthly income (income before taxes). The higher the percentage is, the higher your risk of default becomes. When renting a property, no more than 30 percent of a renter’s annual income should go toward housing costs. because this leaves plenty of money for living expenses such as utilities, food, etc, reducing the risk of default.
What’s Included in your Rent-to-Income Ratio?
The only information you need to calculate your RTI is your total rent payment and total income.
Income to Include in your RTI
You can include any income to the landlord or property manager to use for qualifying purposes. Obviously, this includes your full-time income. But if you have any other sources of income that have a two-year history and will continue for the foreseeable future, you may include them too.
Common examples include alimony or child support you receive or side gigs you run with the income you can prove.
There are 2 ways to calculate your RTI
1. Calculate gross income against a predetermined percentage
Remember, at PGMG, we use 30 percent. In other words, no more than 30 percent of a renter’s annual income should go toward housing costs.
(Gross Annual Income ÷ 12) X .3 = Maximum monthly rental rate.
Here’s an example.
Jan makes $65,000 a year before taxes.
- Rent Payment $1,500 (use either your current rent rate or the new rent rate, whichever is higher)
Jan’s rent-to-income ratio is: $65,000/12 = $5,417 per month x .3 = $1,625
So, YES, in this example, Jan can affored $1,500/mth rent but no higher than $1,625/mth
2. Ratio Multiplier
A ratio multiplier means that the applicant should make at least "X" times his or her gross monthly income to cover rental expenses. In this example, PGMG uses 3 as the ratio multiplier.
Monthly Rent X 3 = Minimum monthly rental income
Here's an example with Jan, again:
Jan is looking at a rental property with a monthly rent of $1,850/mth.
$1,850 x 3 = $5,550
Jan must gross a minimum of $5,550/mth in income to afford a property renting for $1,850.
By using the ratio multiplier against the rental amount, no, as her RTI would be greater than 30%.
BONUS Calculation!
This all may seem confusing because you do not take home gross monthly income.
So, I have a bonus example for you!
Using 2.5% NET monthly income (What you actually bring home minus all your deductions) in your RTI calculation will help you see a bit more insight into your finances when it comes to applying for a property.
Here is an Example:
If you bring home $2,345 every 2 weeks, then your monthly NET is $4,690
$4,690 x .3 = $1407 would be your RTI.
Note: Landlords and property managers also calculate the bigger financial picture. It’s important to understand the bigger financial picture when evaluating an application. Income verification is an important first step. This goes beyond simply verifying employment or running a credit report, which can raise some red flags, such as an applicant who has had a series of sudden late payments.
Final Thoughts
Your rent-to-income ratio is just as important as your credit score. Take the time to figure out your RTI and where you stand before thinking about renting a house. You can review both your credit score and rent ratio early on to increase your chances of application approval. This will also help you from applying to properties that you may not be able to afford and losing your application fee. Rent Smart and know where you stand financially, prior to applying for a property.
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