Rent-to-income ratio is a valuable tool real estate investors use to analyze potential neighborhoods to invest in and qualify and screen tenants.
The calculation is easy to do and helps landlords identify the best tenants who are most likely to pay the monthly rent in full and on time.
What is a rent to income ratio?
The rent to income (RTI) ratio compares the monthly rent a tenant needs to pay to the tenant’s total combined gross monthly income. Combined gross income is the total wages received from every adult tenant living in the home, such as a husband and wife, two partners, or roommates sharing a home to rent.
As a rule of thumb, many investors will say a good rent to income ratio is about 30%, although the ratio will vary based on a market’s median rent and median income levels.
Why the rent to income ratio is important
The rent-to-income ratio is an important tool to use to screen prospective tenants. It helps landlords to avoid tenants with insufficient income and gets tenants to focus on available rental property that they can afford.
In one sense, the RTI ratio is similar to the loan to value (LTV) ratio a lender uses when a real estate investor applies for a mortgage.
If the LTV is too high, the lender knows the odds are greater that an investor may have trouble making the monthly mortgage payments. In the same way, if the rent to income ratio is too high, a tenant may have trouble paying the rent in full and on time.
In addition to the rent, tenants have other expenses such as utilities, grocery bills, child care expenses, car payments and student loans, and medical insurance. When the rent takes up too much of a tenant’s income, they may be unable to pay for other normal costs of living expenses, including keeping the home in good condition.
Or, they may be forced to pay the rent late. When the tenant doesn’t pay their rent on time, the cash flow the property generates is affected. That could cause a landlord to pay his bills late, which in turn reduces the value of the investment due to lower cash flow.
How to calculate the rent to income ratio
The rent to income formula looks like this:
- RTI = Monthly Rent / Gross Monthly Income
There are two ways a landlord can use the rent to income ratio to determine if a tenant can afford the monthly rent:
Use a predetermined RTI ratio
Although the standard rent-to-income ratio will vary by market, generally speaking, a maximum of 30% of a tenant’s gross income should be used to pay the rent. For example, if a tenant’s combined gross annual income is $50,000 the maximum rent would be:
- Gross Monthly Income x RTI Ratio = Maximum Monthly Rent
- $50,000 Annual Gross Income / 12 Months = $4,167 Gross Monthly Income
- $4,167 Gross Monthly Income x .3 (30%) RTI Ratio = $1,250 Maximum Monthly Rent
Use an RTI ratio multiplier
The rent-to-income formula can also be used to calculate how much combined gross income a tenant needs to pay the asking rent. If the rent in a single-family home is $1,500 per month, using the RTI multiplier a tenant would need a combined total monthly gross income of $4,500 to qualify to rent the house:
- Monthly Rent x RTI Ratio = Minimum Monthly Income
- $1,500 Monthly Rent x 3 RTI Ratio = $4,500 Minimum Monthly Income
How to determine the market RTI
Real estate investors can also use the rent to income formula to calculate the median rent to income ratio in a specific real estate market:
- Market RTI = Median Market Rent / Median Market Income
Based on the above formula, we need to know two pieces of information: 1) Median rent in the market and, 2) Median household income in order to solve for the market’s median RTI.
A good resource to find the median household income by market is Data USA. The website was created by Deloitte, Datawheel, and a professor at the MIT Media Lab.
Three good sources for finding median market rent are Zillow Research Data, Zumper, and RentData.org. One advantage to using the Zillow Observed Rent Index (ZORI) is that rent data is available by zip code, while Zumper and RentData provide median rent information on a macro market level.
Example of calculating the RTI for Austin, Texas
In this example, we’ll determine the median market rent to income ratio for Austin, Texas as of May 2021.
According to Data USA, the median household income for the Austin-Round Rock metropolitan area is $76,925. Based on information from Zumper, the median rent in Austin is $1,550 per month. Using this data, we can calculate the market RTI for Austin:
- Market RTI = Median Market Rent / Median Market Income
- $76,925 Median Household Income / 12 Months = $6,410 Monthly Income
- $1,550 Median Market Rent / $6,410 Monthly Income = .24 or 24%
This means that the median rent to income ratio in Austin is below the rule of thumb of 30%. Based on the RTI for Austin, a real estate investor may predict that the median renter in the Austin metropolitan area earns more than enough income to pay the median market rent.
Pros and cons of this metric
The biggest advantage to using the rent-to-income ratio is that it is easy to calculate for both the landlord and prospective tenants. If the tenants know they don’t have enough income to qualify for the rental, they won’t spend money on the application fee or waste the landlord’s valuable time.
On the other hand, the rent to income ratio measures a tenant’s ability to pay the rent, but not necessarily their willingness to pay in full and on time.
Sometimes, renters with lower income levels are much more conscientious about paying the rent than are higher wage earners. In some cases, lower income renters believe they have nowhere else to go, so they do their best to pay their rent on time and to take good care of the home they are living in.
Also, the RTI ratio doesn’t take into account the fact that in many markets rents are rising faster than income levels are. In Miami, for example, the RTI is nearly 47% based on the median market rents and median household income levels.
Tips for getting the rent paid on time
Even when a tenant has the rent-to-income ratio a landlord is looking for, in the rental property business, there is always the risk of the rent not being paid on time. Steps a landlord can take to find good tenants who pay the rent on time include:
Online Tenant Screening
Online tenant screening services such as Cozy, Rentberry, Zumper, and Avail offer free tenant screening reports to landlords by charging prospective tenants an application fee. Asking the tenant to pay a fee is a normal business practice when renting homes, and also helps to discourage tenants from applying who may not have enough income to pay the monthly rent.
Maximum Security Deposit
A refundable security deposit is collected by the landlord to help ensure the tenant will meet all of the terms and conditions of the lease, such as paying the rent in full and on time and taking good care of the home. If they don’t, landlords usually have the right to use the security deposit to pay for unpaid rent, fees, and damage to the property caused by the tenant.
The security deposit limits vary by state, with most states setting the maximum security deposit equal to one to two months of rent.
Have All Tenants Sign The Lease
By having each adult tenant sign the lease agreement, a landlord can hold each signer responsible for the total monthly rent due. Co-signers on a lease can improve on-time rent payments because each tenant is personally liable for the rent.
If the worst-case happens and a landlord needs to evict, judgments can be obtained for each tenant for the total amount of unpaid rent.
Accept Rent Payments Online
One of the reasons why online rent payment services have become so popular is that they make it easy for tenants to pay the rent on time. Pay rent online payment tools such as PayYourRent, Rentec Direct, RentTrack are three popular options for paying rent online.
These services will automatically remind tenants when the rent is due, offer multiple options for paying the rent online, and report on-time rent payments to TransUnion and Experian RentBureau to help tenants improve and maintain their credit history.
Wrapping up
The rent to income (RTI) ratio compares the monthly rent of a home to the tenant’s total monthly gross income. RTI is a quick-and-easy screening tool that both landlords and tenants can use.
Landlords can quickly pre-screen potential applicants by setting a minimum acceptable rent to income ratio. Tenants can use RTI to identify available rental properties that are within their budget, to avoid wasting their time as well as the landlord’s time.
