Finding an ideal tenant buyer for your lease options is easier than you might think – when you use a reliable process. Today’s real estate market is well suited for finding plenty of applicants ready to buy on a sandwich lease option. Still, knowing how to screen tenant buyers is an important part of selling with lease options.
How to Screen Tenant Buyers Using a Fair Process
One important thing regarding how to screen tenant buyers is having a consistent process. This is mostly a legal requirement to keep you on the right side of the Fair Housing Act. The Federal Fair Housing Act requires that you not discriminate based on race, color, religion, sex, disability, familial status, or national origin. The best way to do this is by having a fair process that applies equally to everyone. But this doesn’t mean you can’t have strict criteria for qualifying your buyers.
People have unique reasons why the lease option purchase process works best for them. And many do make very good prospects for buying your house in a year or so. But these people also usually have life events requiring a little time to overcome. Commonly, you can expect buyers to have their own version of one these situations:
- They are newly self-employed and need to establish a 2-year work history.
- Similarly, they have a new job where they need to establish a 2-year work history.
- Their credit score is slightly below qualifying for a mortgage.
- They are still saving for a down payment.
You can easily work with every one of these and other unique situations to sell your house with a sandwich lease option for a win-win-win result. You simply want to use criteria putting the best-qualified applicant in the house. How to screen tenant-buyers can be done in one of two ways. You can have a professional mortgage broker do most of the screening or you can do it yourself.
How to Screen Tenant Buyers Using a Mortgage Broker
Using a mortgage broker makes very good sense because this is the process for buying the house, which is your goal. Traditional renter screening services use different criteria than what mortgage brokers use. For instance, the buyer may have a low credit score but a high enough income to otherwise qualify to buy the house. A mortgage broker knows exactly how these numbers work and can quickly determine which applicants are most likely to qualify within 24 months.
For someone new in a job but with a good salary, it’s very easy for a mortgage broker to determine when the applicant is likely to qualify. Same thing for someone working on saving for a down payment. This is all part of the mortgage pre-qualification process that brokers work with every day. The process is typically for the applicant to complete a 1 or 2 page application that the broker evaluates. The broker can have an answer in about a day.
You may have to talk with a few mortgage brokers to find one who understands lease options (although what the broker is doing is their routine pre-qualification process). What’s in it for the broker is they are creating future clients who will stay with them to obtain their mortgages. One thing you want to do is get the application from the broker so that you can have your tenant-buyer complete it without the broker having to go back repeatedly for unanswered questions.
You also get something extra out of this regarding how to screen tenant buyers. Applicants that are quick to fill out the simple form and get it back to the broker are more likely to follow through with the home purchase than applicants who drag their feet early in the process.
How to Screen Tenant Buyers Yourself
You can use a mortgage pre-qualification form to develop your own process. One of the first things you want to know is your applicant’s debt to income ratio (DTI). It’s a good tool for any landlord and an especially important step in how to screen tenant buyers. Since your end goal is selling the house to your tenant, your screening process needs to be very similar to that used to qualify homebuyers.
The DTI ratio is a measurement of the tenant buyer’s ability to not only make the house payment but to also make payments on other debts. The ratio has two components:
- The numerator is the total monthly obligations. This includes the payment for the mortgage loan and other long-term and significant short-term monthly debts.
- The denominator is the total monthly income of all borrowers, to the extent the income is used to qualify for the mortgage.
For example, if the tenant buyer pays $1500 a month for the mortgage and another $150 a month for an auto loan and $350 a month for the rest of his/her debts, the monthly debt payments are $2000. ($1500 + $150 + $350 = $2,000.) If the tenant buyer’s gross monthly income is $6000, then the debt-to-income ratio is 33%. ($2000 is 33% of $6000.)
Fannie Mae is the go-to source for defining the allowable DTI ratio. Currently, Fannie Mae’s maximum is 36% of the borrower’s stable monthly income. The lower the DTI ratio, the better because it means more income is available to repay debt. Fannie Mae’s maximum can be 45% if the borrower meets higher credit score and reserve requirements.
The tenant buyer’s numbers will change over time. You want to start with a tenant having a relatively good DTI but don’t expect it to meet the Fannie Mae requirements.
Another important part involving how to screen tenant-buyers is their credit score. Depending on your applicant’s current circ*mstances, they may or may not meet the minimum credit score requirements, which are:
- FHA Loan – 580+ credit score (500-579 score is possible but unlikely).
- VA Loan – 620+ credit score (some lenders allow 580).
- USDA Loan – 640+ credit score.
- FHA 203K Loan – 620+ credit score.
- Conventional Loan – 620+ credit score.
You’ll need to decide how far below the thresholds you’ll allow a tenant-buyer to be before you enter into a lease option agreement with them. The FHA standard is the logical place to begin considering an acceptable credit score. Many first time buyers apply for FHA loans because they also require a low down payment (3.5%) along with allowing low credit scores. However, you need to consider all of the person’s circ*mstances. For instance, a VA loan may be a better option although it requires a higher credit score because some VA loans are available with a zero down payment. In any case, your standard for how to screen tenant-buyers might be having a credit score no more than 50 points below what will qualify for a loan.
Now is a great time to be a lease option investor. If you want to learn advanced methods of how to screen tenant buyers, leave a comment below or contact my office at wendypatton.com/contact.
By Wendy Patton
For more than 35 years, I’ve used the Sandwich Lease Options System to earn myself and my students multiple millions of dollars. From my experience, I know there is plenty of room and opportunity in the real estate investment market for everyone wanting to participate and find profitable deals. It’s because of that fact and my personal success that I share the Sandwich Lease Option System with others.
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