Since this article was first published, there have been updates in Colorado's property laws. In 2023, the state legislature passed Senate Bill 23-184, which modifies the income-to-rent ratio for tenant qualification. Previously, the standard was that a tenant's income should be at least three times the annual rent (3X rule). However, in Colorado, this has now changed to a 2X rule, meaning landlords can only require a minimum income of 200% of their annual rent to qualify. Here is an article that explains this new law and other aspects of SB 23-184.
If you’ve been renting or looking to rent for a while, you’ve probably come across the “3x rent rule.” The 3x rule is a common way landlords and property managers vet potential tenants. It states that a tenant’s adjusted gross income, or take-home pay, should be 3x the proposed rent on a property.
Adjusted gross income is your total monthly income minus any deductions, like taxes, alimony, interest from student loans, contributions to an IRA or 401k, or a car payment.
If we look at a property with a monthly rent of $2,000, for example, the 3x rent rule states that a tenant must have a gross monthly income of $6,000 or $72,000 annual salary to qualify for that rental. The income itself can come from wages, dividends, capital gains, or retirement accounts.
The rule generally applies to household income, so a couple’s combined annual gross income must be 3x the monthly rent amount. But in many roommate situations, the landlord will require each roommate to meet the 3x rule separately to ensure that they still have a viable tenant if someone decides to move out.
While this can be a headache for prospective tenants, especially in areas where rental rates outpace average income, the 3x rule protects landlords from missed payments and helps prevent evictions.
Background: Housing Act of 1937
The 3x rule originated in the Housing Act of 1937, which was part of FDR’s New Deal. The Housing Act offered housing assistance to low and moderate-income families.
The Act was originally proposed in 1934, but wasn’t passed until FDR’s second term. In his second inaugural address, President Roosevelt promised to make adequate housing a priority and signed the act into law in September of 1937.
Section 8 of the Housing Act offers federally-subsidized rent assistance to families in the private market. Section 8 requires families to pay 30% of their adjusted income toward rent. The program then covers the gap between 30% of their income and the actual rent cost.
This eventually became the standard rent-to-income ratio for the housing market.
Why the 3x Rule? Prequalifying Prevents Evictions
Section 8 explains where the 3x rule came from, but why do we still use it? What if an individual can afford to spend 40% of their income on housing? Shouldn’t they be able to qualify for a more expensive rental?
Though it can have drawbacks, the 3x rule is an important part of the prequalification process. It is not one-size-fits-all, but if your income is 3x larger than the rent, you are less likely to miss a rent payment or regularly struggle to afford rent.
Evictions are horrible for everyone involved. Tenants are thrown into temporary turmoil at best, and homelessness at worst. The property owner loses money from missed rent and spends time, energy, and resources pursuing an eviction and back rent.
Pre-qualifying tenants can help minimize the likelihood of an eviction, protecting the tenant and landlord from pain and heartache. The 3x rule benefits both parties by ensuring the tenant doesn’t get locked into a lease agreement that they can’t afford, and that the landlord receives their payments on time.
Ideally, landlords and property managers will use the 3x rule as one part of the prequalification process, but also run a credit check, talk to references and previous landlords, and verify employment.
Meeting the income requirement is only one piece of the puzzle.
How Landlords Can Verify Income
Gathering proof of income can be a lot of work for an independent landlord. Tracking down income verification documents, bank statements, and making phone calls eats up a lot of time, but again, the goal is to prevent evictions. Finding the right tenant upfront will save you time and money down the road.
We have compiled a list of items to check with different types of tenants—employed, self-employed, and retired—to simplify the verification process for you.
Verifying income for employed applicants is the simplest, but you can also find excellent self-employed and retired tenants. Just be prepared to do a bit more legwork
For employed applicants, ask for pay stubs from the past 3 months. This will give you an accurate picture of their current earnings and cover a long enough period to reveal any fluctuation in income.
W2s show total income from the previous year. W2s can indicate how financially stable an applicant is and if their earnings are consistent. If the applicant has changed jobs, however, this may not be particularly useful.
Lastly, a simple phone call to the applicant’s employer will offer insight into their employment status and character. Consider asking what the applicant is like as an employee. Do they show up on time, work hard, and get along with their coworkers?
This group of applicants includes freelancers, gig workers, and entrepreneurs. We value and admire our freelancers and small business owners, until they want to buy or rent a home.
We often perceive small businesses as more susceptible to market changes—they may not have the financial stability to weather dips in the economy. This perception can make it difficult for self-employed individuals to get approved for a rental or home loan. But it doesn’t have to!
Plenty of industries that provide consistent and stable work to freelancers and gig workers. Just because a business is small, doesn’t necessarily mean it’s vulnerable. Even large companies can go through periods of financial struggle and layoffs.
If you are willing to do a bit of initial research, you may find yourself with an amazing, reliable self-employed tenant.
Bank statements from the applicant’s business account will give you the most comprehensive information about their earnings. Look for consistent deposits, and make sure that expenditures don’t exceed their deposits—this could indicate a lack of profit.
Talk to the applicant. Ask them how long they have been in business and what services they offer. You can also ask about industry stability, or research the industry yourself once you have a bit more information.
Research the business. Are they registered with the state government? Do they have a business license (if one is required)? Colorado Springs, for example, only requires licenses for specific industries, like food and liquor. Also, see if they have a professional website.
Checking the applicant’s credit report will reveal any red flags, such as a history of late payments, or any bankruptcies or foreclosures. You’ll also want to pay attention to balances on loans and credit cards.
Previous landlords are a great resource for any potential tenant, not just self-employed ones, since they can answer questions about payment history. Most importantly, ask if they would rent to the tenant again!
Unemployed or Retired Applicants
It can be difficult for retirees and the unemployed to qualify for rentals, since the same pre-qualification standards are used for all applicants. They may not have a consistent income, or may not have the necessary verification documents. Here are a few examples of documents to ask for in this situation.
Social Security statements are a great place to start, as Social Security provides a steady source of income for retirees that can be easily verified.
Ask for annuity statements. Many retirees rely on annuities to replace their paychecks, and this income can also be used during the verification process.
IRA, 401k, or pension distribution statements can also help verify income.
Bank statements will reveal any consistent deposits that are not listed on the previous types of statements. They may have another way to supplement their income that does not fall into any of the previous categories.
If you have an unemployed applicant, ask them to provide unemployment statements. These statements act as proof of income from the government.
Qualifying When You Make Less Than 3x
We mentioned at the beginning of the article that the 3x rent rule can make finding a place difficult. In many markets, wages do not keep pace with housing costs. Unfortunately, our own lovely Colorado falls into this category.
In 2019, the Denver Business Journal published an article, saying that the average wage earner in Denver cannot afford to buy a median-priced home. For workers making $65,000-$75,000 a year, over 40% of their income would go toward their mortgage.
Home and rental prices are continuing to climb, leaving prospective tenants without many options. Some will seek out roommates, hoping to pool their incomes to meet the 3x rule. This doesn’t always work. Many landlords and good property managers will expect each tenant to meet the rule separately.
This is an understandable precaution since roommates can move out without notice, but where does that leave you? If you are hoping to rent with roommates, a private landlord may be more flexible with income requirements than a property manager or institutional one.
You can also work to strengthen your rental application in other ways to compensate for your financial situation. Having a good credit score is especially important in these situations since it demonstrates that you pay your bills on time and take your financial commitments seriously. Adding a cosigner or making a larger security deposit can convince a landlord that you are less of a financial risk.
Some rentals don’t require an income check. If you know you can afford a house or apartment, but don’t meet the 3x rule, this may be an ideal situation for you. Just be careful not to overextend yourself financially.
Rely on word of mouth to locate a private landlord that will consider your application. Think about the Kevin Bacon effect. If every actor can be linked to Kevin Bacon in 3 steps or less, someone in your network can put you in touch with a suitable landlord or point you toward an apartment in your price range.
Find a roommate already in a lease, which will eliminate the need for you to pre-qualify. Make sure that you have a written rental agreement with your roommate, laying out terms and financial responsibilities.
Also, if you can’t afford rent in your home city, Section 8 was made for you! In general, your household income cannot exceed 50% of the median income in your area to be eligible. You can check out our blog post, “What is Section 8?” for more information.
Takeaways for Landlords and Tenants
The 3x rule is a good general rule of thumb for landlords to protect themselves from missed rent and the messy process of evicting a tenant, but it is not a perfect solution. A tenant may miss payments for reasons other than an inadequate income, or a tenant that wouldn’t normally qualify, may be perfect for your situation.
If you are a private landlord, think about rental costs in your area vs average wages. If it is not a favorable ratio, consider how you might compromise with potential tenants without putting yourself at risk. Maybe you’re okay with roommates pooling their incomes, or would accept someone with a lower income level if they paid a higher deposit?
If you are a prospective tenant with a lower income, focus on strengthening other key parts of your application, such as your credit score. You can also brainstorm people who might be willing to cosign for you, such as a trusted family member.
And, of course, ask around! There are private landlords that are willing to work with a good tenant, even if they don’t meet the 3x rule.