If you’re new to renting out investment properties, you’ll have to get acquainted with the practice of collecting security deposits from your tenants. So, we’ve put together some basic introductory information about security deposits to help you understand how they work. Of course, there are differing state and local laws that govern various aspects of collecting, holding, claiming, and returning security deposits, so be sure to research these rules and regulations in the location of your properties.
What Is a Security Deposit?
Basically, a security deposit is a refundable amount of money that landlords collect up front to protect themselves if a tenant doesn’t honor the terms of their lease agreement or causes damage to the property beyond normal wear and tear.
The security deposit remains the tenant’s money; it isn’t additional income for the property owner. Some unscrupulous landlords never intend to return this money, and consider it additional income. This is unfair and illegal. Money from a security deposit only rightfully becomes the landlord’s if it’s covering an expense incurred due to the tenant’s failure to meet payment terms in their lease or to leave the property in acceptable condition at move-out.
How Much Should You Collect for a Security Deposit?
In general, landlords should charge as much as their market will allow for a security deposit. If you need the money to cover extensive damage to your property, you’ll certainly wish you had as much as possible. However, the most common practice is to collect the equivalent of one month’s rent; don’t ever charge less than this amount. Also, there are legal limits on the amount you can collect for a security deposit in many places, so be sure to check into this in the local jurisdiction of your property.
When Should You Collect a Security Deposit?
In addition to its other purposes, a security deposit is also a part of tenant screening. Along with other important aspects like knowing what information to ask for on a rental application and performing employment verification, a security deposit helps you acquire tenants who are less likely to be problematic. For this reason, always collect the full amount of the security deposit up front at the lease signing, along with the full first month’s rent.
If a tenant is unable or unwilling to pay the full amount of the security deposit at the time of the lease signing, this is a major red flag. It may indicate an individual who’s financially unstable or who has no access to emergency funds, or one who simply doesn’t honor payment agreements.
Don’t negotiate about security deposits, and don’t agree to installment payments. Some prospective tenants may tell you they’re waiting on the return of their security deposit from their previous landlord, and say they will pay you with this money. Again, this is a red flag that a person could easily have trouble meeting the financial obligations of their lease. Also, there’s no guarantee they’ll get any or all of that previous deposit back.
How Should a Security Deposit Be Paid?
Only accept a guaranteed form of payment for a security deposit (as well as the first month’s rent). Typically, this means a money order or a cashier’s check. Do not accept a personal check for payment of the security deposit or first month’s rent. Otherwise, you may find yourself in the situation of already having signed the lease, and having the check bounce.
Should You Create Deposit Categories?
Some landlords break down the security deposit into categories like “Pet deposit,” “Cleaning deposit,” Damage deposit,” and so on. This is generally not a good idea. If you do this, you then limit the amount of money from the deposit you can apply to a particular cost. For example, if you only collect $300 specified to cover damage to the property, you cannot also use money earmarked for cleaning costs to help cover $500 worth of damage.
What About Charging Fees?
Deposits and fees are not the same thing; the former are refundable, the latter are not. Some landlords charge items like a “Pet fee” or a “Cleaning fee.” These must be specified in the lease as nonrefundable fees. While these may increase your income from a property, charging fees in addition to a security deposit can make your property less competitive. Also, they remove incentive for the tenant to act responsibly. For example, if they’re charged a nonrefundable $200 cleaning fee, why would they bother cleaning when they move out?
Fees are often associated with pets. There are good reasons to allow pets in residential rental properties, but most landlords wisely want to protect themselves against the extra damage animals can cause. You can charge an upfront pet fee for the privilege of allowing a pet, or you might charge a small amount of additional monthly pet rent. You might also collect a larger security deposit or collect a separate pet deposit, but these must be refunded if not needed to cover expenses (and specifically pet-related damage expenses if you specify a pet deposit). Choose whichever option you’re most comfortable with.
