Table of Contents
- What is Proof of Income?
- Why do you need it?
- How to show Proof of Income
- What is an ideal rent-to-income ratio?
- How to use the rent coverage ratio?
What is Proof of Income?
A proof of income is a document that states how much someone is earning for the purpose of verifying whether he or she has the capacity to pay for something. In the case of renters, a proof of income is a document your new possible tenant uses to give you, the landlord, assurance that he or she can afford to pay the rent. Although a pay stub is the most commonly used proof of income, there are a number of other documents you can also use to affirm your income, even if you’re self-employed.
Why do you need it?
It’s pretty common for landlords to require proof of income before agreeing to sign a lease agreement. This is because a proof of income provides landlords a guarantee that they will get the money they deserve, which decreases their risk.
How to show Proof of Income
When landlords demands proof of income, renters are asked to submit certain documents as evidence. Generally, renters are asked to produce at least two forms of proof of income, so that landlords can protect against false claims.
Proof of Income documents
The documents below are the most common forms of proof of income. However, if your tenant has other documents that he or she wishes to use as evidence, talk to him or her about it. Some documents hold more weight than others, so definitely discuss what constitutes appropriate proof of income before accepting anything to avoid a hassle. Do your research before accepting these alternate proofs of income!
Also known as a pay slip, a pay stub is a document from your tenant’s employer that delineates how much he or she is being paid, including any deductions.
This is commonly considered the strongest proof of income.
Where you should be careful: Contact the employer so you can check the validity of the pay stub.
Proof of Income letter
Also known as a salary verification letter, a proof of income letter is a letter written by your renter’s employer that describes what his or her role in the company is, how much he or she is earning, as well as how long he or she has been working there. Depending on how close your renter’s relationship is with his or her employer, this can also serve as a letter of recommendation that further assures the landlord that the renter be a trustworthy tenant and not one he or she should avoid like the plague.
Where you should be careful: Confirm with the employer about the proof of income letter, since this document can easily be forged.
A tax return is a document that reports the tenant’s income to either a national, state, or local tax agency, and helps determine how much he or she pays in taxes.
Where you should be careful: Verify the date of the tax return to make sure it’s current.
Social security statement
A social security statement is a document from the Social Security Administration that uses the renter’s earning history to determine how much he or she will receive in benefits in the future. You can go online at mySocial Security to acquire your social security statement.
Where you should be careful: A social security statement may be one of the most reliable forms of proof of income, since it’s easy for renters to access and it’s a federal document. However, how effective it is for proving income highly depends on how the federal government decides to handle social security in the future.
Bank statements are documents issued every month that disclose all of your transactions, including any withdrawals, deposits, or fees. This would include any income that gets deposited into your account.
Where you should be careful: Bank statements reveal a lot about your would-be tenant’s life, so be delicate when asking for this particular document and treat it as a last resort.
Proof of Income for self-employed individuals
If you’re self-employed, don’t worry! There are still documents you can furnish to vouch for your income.
IRS Form 1099 Miscellaneous Income
If your renter is a freelancer, Form 1099-MISC is a form that he or she should complete for each job that pays him or her at least $600. Make sure to have your renter gather all of his or her 1099-MISC forms and turning them over to you so that you know that your renter is capable of securing income for him or herself, even if he or she doesn’t have a traditional job.
Where you should be careful: When relying entirely on 1099-MISC forms, it’s difficult for landlords to determine the renter’s monthly income, since it’s no guarantee that the renter will be able to secure as many jobs next month.
A tax return would be great proof of income for self-employed individuals because it contains income information gleaned from your 1099-MISC forms, as well.
Similarly, even without a regular job, bank statements are a strong supplement for proof of income because they track any income that gets deposited into your account.
What is an ideal rent-to-income ratio?
Now that your tenant has turned in their proof of income, how can you tell if the tenant has the means to lease your property? One way is to look at the rent-to-income ratio. Generally, the standard is that the rent should be 30% of your tenant’s income. If the rent is more than 30% of the renter’s income, then your renter runs the risk of not making enough cash to pay for his or her lifestyle, and by extension, may not be able to pay rent regularly.
Calculating rent-to-income ratio
Let’s say your income was $30,000/year and the rent for the property is $1,000/month.
$30,000/12 months = $2,500
$2,500 * 0.30 = $750
The tenant can afford up to $750 in rent, making the rent for this property is too high.
If math is not your strong suit, check out this online rent-to-income calculator. Just enter how much is the desired rent-to-income ratio and the tenant’s salary, and the calculator will tell you how much rent your tenant can afford.
How to use the rent coverage ratio?
Another helpful ratio that you can use to determine whether or not your tenant has the means to pay rent is to the rent coverage ratio. This ratio is calculated by dividing your income by your total expenses. A good rent coverage ratio is 1.3 or higher. So, similar to the rent-to-income ratio, if your calculations yield a rent coverage ratio lower than 1.3, you step into the dangerous territory of your renter not being able to afford rent.
Calculating rent coverage ratio
Let’s stick to the example of your income being $30,000/year and your rent is $1,000/month.
Total expenses: $23,000
- Rent: $12,000
- Utilities: $3,000
- Food: $3,700
- Cable: $1,800
- Phone: $1,200
- Car: $1,300
$30,000/$23,000 = 1.3
The ratio is exactly 1.3, making the rent affordable by the tenant.
When the landlord agrees to take on a tenant, an essential consideration is whether or not the renter can afford to live at your property. Thus, it’s important for landlords to know what constitutes a proof of income so that he or she can easily determine if the renter will be a fitting tenant.