SETTING YOUR CREDIT POLICY

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Time wounds all heels.  It also wounds everybody else.  Even the best of tenants is likely to fall on hard times.  If you will do landlording for any length of time, then some tenant is going to end up owing you money.  Most people do not think of landlords as creditors, but the truth is, even if the rent is due in advance on the first of the month, you are still extending credit – in the broadest sense of that term.  The removal of a non-paying tenant typically will take about a month or more.  So, if you have just rented one of your units, you have become one of the tenant’s general creditors for that month’s rent.

            The scope of this article is to consider the policy you will follow in deciding when, how, and to whom you will extend credit.  You may as well think about it now, because you will need it.  The vicissitudes of life guarantee it.  We will not consider tenant screening, as this is the subject of other articles.

            In formulating your policy, keep foremost in mind what it is for.  It is to benefit you, not the tenant.  It is not a resource of which tenants may avail themselves when they need it.  It is a tool for you to use in making decisions in problem cases.

            Your credit policy should span all aspects of the rent loss risk you bear when you transfer occupancy of a piece of property to another.  These include size of the initial security deposit, grace periods, follow up time frames on late rental payments, eviction notice service dates, delinquency payment schedules, and so on.  There are several factors that you should consider in formulating this policy.

            Landlording is a business.  As with any business, its sole function is to generate and protect assets.  Cash, the ultimately liquid and most useful of all assets, is the ultimate goal of conducting the landlording business, and, so, your cash position is the most important of all considerations, though not the only one.  By this is meant not only the cash position before a default in rent, but also after one.

            A landlord with a 100-unit building with one non-paying tenant has a one per cent loss of his total cash flow.  His credit extension decision will be motivated quite differently from a landlord with a free standing house and a non-paying tenant, and is suffering a one hundred per cent loss of cash flow.  The former landlord may be able to afford generosity, the latter may not be able to do so.

            How tough are you?  While it is clear that landlording is a business, it is a business that affects people’s lives most directly.  Some people can look a single mom with two kids in the eye on the third of the month and serve a three-day notice to pay or quit.  Others cannot.  If you cannot, maybe the risk of an extra few hundred dollars rent loss is preferable to the loss of many nights of sleep.

            How much experience do you have in the business?  Unfortunately, some tenants are con artists who make a substantial part of their income by beating people out of just debts.  Others are good intentioned but simply scatter brained.  Some are quite responsible, and salvageable, but are experiencing a short term run of bad luck.  Do you have enough experience to tell the difference among them?

            What are the demographics in the area and the building in question?  Buildings in low-income areas will inevitably have a higher rate of delinquency than those in more affluent ones.  Furthermore, the eviction of one tenant with problems may only result in his replacement by another with a similar problem.  It may be more profitable, in the long run, to work with such tenants, rather than to evict immediately.  You must consider this risk when buying the building in the first place.

            What the competition is doing impacts greatly on any credit policy.  In an area with high vacancy rates, in which security deposits are being waived and free microwaves given to tenants who will sign a one year lease, it is pointless to demand two months rent in advance as a security deposit.

            The degree of government regulation is also a vital consideration.  Contrary to intuition, the more strictly the locality or the State has controlled rent and evictions, the less inclined you should be to extend credit concessions to delinquent tenants or new move-ins.  Such regulation usually means expensive and lengthy evictions.  Outreach programs ensure the tenant is advised of and avails himself of every delay and expense generating procedure available under the local or state law.  For this reason, it is usually better to bite the bullet and get it over with, than to get deeper into the problem before the inevitable process even starts.

            Now that you have decided how much security deposit to charge, how long the grace period will be, what you will do upon delinquency, and so forth, put it in writing.  Even if you have only a couple of rental units, the exercise of writing it down and putting it in your business records will help to provoke foresight, reinforce your decision, and give you a reminder to refer to when the inevitable problem arises.

            Do not, ever, divulge what your core policy is.  Once your tenants know what your policy actually is, it may become the ceiling for their rent payment performance.  If you have decided, for example, that you will extend a formal grace period to the fifth of the month, and put it in the contract, as you should, but that no three day notices will be served until the fifteenth, do not expect to receive the rent from many of your tenants much before the fourteenth if your tenants all know about your policy.  As far as the tenants are concerned, you get your rent within the grace period and that is that.  Leave them in the dark as to what may happen after that.  As motivations go, uncertainty is far more compelling than a known threat.  In other words, you will have two policies, one for your tenants to know, and one that only you know.

            Once you have gone through the discipline of thinking it through, follow the policy.  Follow up on delinquencies as planned and do not allow yourself to be deflected from your policy frivolously.  Be even handed in your dealing with all your tenants and gauge their performance by the same criteria.  Keep in mind, though, no plan completely survives contact with circumstances.  Be prepared to stretch your policy, but do it advisedly, with good reason, and only if you have something clearly in mind and can afford it.  The remainder of this article will deal with this subject.

            Now you have a tenant on your hands who has not paid his rent by the expiration of the grace period.  There is a reason for this, so find out what it is.  Talk to the tenant.  Evaluate the reason given – it may be satisfactory or it may not be.  Even if your visit is concluded with the tenant handing you the rent in cash, including the late charge, it is a red flag, and this tenant merits further attention.  The warning signs are obvious:  rent payments coming in progressively later, offers of partial payment, apparent marital problems, difficulty reaching the formerly communicative tenant, a tenant who is around all day when he used to be at work, a car which used to be parked in the assigned parking is now missing (repo?).  Keep in communication with all your tenants and evaluate such communications not only with a view to the subject at hand – maintenance, for example – but also for what may be going on behind the scenes.

            In the event the tenant is unable to pay the rent, you must decide what to do.  Jumping into the eviction process right away may be the best solution, but it is not always.

            What is the tenant saying about the problem?  Does he provide a credible, succinct reason for the late payment, or is he giving vague excuses about a temporary cash bind?  Does he seem to have concrete plans to resolve the problem, or is he just playing for time?  You will want to consider how long the tenant has been in possession and what his history with you is.  Longevity weighs in his favor. 

How current the information you have on him is is critical, though.  If his credit application was filled out ten years before, you might want to make a friendly request that he fill out a new one as a condition to any payment plan.  Indeed, in the case of any default, getting updated credit information is a good idea.  Determine what the tenant’s overall credit position is from this, and check him with the same care with which you would check a new move-in.  Be sure to get current employment and bank account information as a minimum in case the worst happens.

It may not be advisable immediately to suggest a payment plan in any event.  Explore other possibilities, such as the tenant obtaining a loan from a friend or relative, a credit card advance, or a voluntary informal assignment of a portion of his wages directly from his employer.

Once you make the decision to permit the tenant to catch up on an arrearage, and have exhausted all the other possibilities, make sure that whatever arrangement you make satisfies all five of the following criteria.

-         when will each payment be made?

-         what will be paid?

-         how will the payment be made – cash, check, money order?

-         where will payments be delivered?

-         what is the source of the funds?

Now put it all in writing.

            Be sure to take adequate precautions.  If you have not already done so, get updated employment and credit information.  See if you can get a co-signer to the rental agreement and the repayment agreement.  Check the local municipal court records and pull a credit report.  These things are easy to do and may turn up valuable information on pending collection actions.  Verify employment by contacting the employer.

            Finally, keep in mind that you are looking at the distinct possibility of rent loss and you want to avoid or minimize it.  You would like to believe you will get your money, but ask yourself if your belief is realistic.  Most companies do not allow credit decisions to be made by their salesmen, who have a stake in closing the deal.  Take a tip from them and run the situation and information you have at hand past a trusted friend or professional financial or legal advisor.  Give their judgment great weight.  (N.B., if you run the situation past a friend not in a confidential relation with you, e.g., lawyer, accountant, etc., do not give that person confidential credit or other personal information you have obtained about the tenant.)

            We will not go into setting up a new payment plan if the tenant breaches the first one, because if you even think about it you are simply doing it wrong.

            We have covered some of the major considerations to the credit decisions you will have to make as a landlord.  This cannot be a cookbook of decision recipes since each situation you might face will be different.  Use it instead as a tool to stimulate forethought in dealing with your credit problems.

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