Everything You Want to Know About Security Deposits but Are Afraid to Ask

Security deposits are designed to protect landlords from tenant damage to the property and nonpayment of rent. Seasoned landlords understand that collecting a security deposit from a tenant is nearly as important as collecting the monthly rent. This one-time, refundable fee (as long as the tenant leaves the property in good condition) is in addition to their first month’s rent.

Here are three things to consider about attaining security deposits for your rental property in order to protect yourself and your property.

How Do You Determine a Security Deposit?

Security deposits are typically set at one month’s rent, but there are exceptions. That means if a tenant moves into a rental home that charges $1,000 a month in rent, a landlord should require $2,000 upfront ($1,000 for first month’s rent and an additional $1,000 security deposit) from the tenant in order to secure the property.

But even this is not written in stone. A safer way to calculate security deposit amounts is to consider tenant risk. When it comes to security deposits, it’s best to err on the side of caution. Good landlords who know what they’re doing rarely take less than one month’s rent, and neither should you. So let’s assume a security deposit doesn’t go below one month’s rent. But are there times when you should ratchet up the figure based on an applicant’s evaluation that gives you pause?

You betcha! Here are some typical scenarios that should make you consider increasing the security deposit:

• There are some prior gaps in the candidate’s income. However, over the last couple of years their work history has stabilized. They have been able to maintain an appropriate ratio in terms of their income to their monthly rent, which is three to one as a general rule (see next bullet point).
• Their gross income hovers on the threshold of acceptability. In order to rent a $1,000 a month home, the candidate should show a gross household income of $3,000 a month. Let’s say an otherwise great candidate but earns only $2,800- $2,900 a month.
• The prior landlord’s report doesn’t paint them as a stellar tenant, but everything else checks out.
• Your corporate policy doesn’t accept tenants that have been evicted from their rental property within the last seven years. This tenant had an eviction ten years ago.

If you’re feeling a little queasy or unsure about the tenant’s ability to pay, you’re perfectly within your rights to ask for additional security. Keep in mind that you want to charge enough to protect yourself from damage and nonpayment, but not so much that potentially good tenants are discouraged from renting your property.

What Restrictions Exist for a Security Deposit?

Legal restrictions on what you can and cannot use security deposits for varies from state to state. But in general, landlords cannot:

• Use the security deposit as a personal piggy bank. For example, let’s say that a tenant punches a hole in the wall. As a landlord, you go in and inspect it and determine it needs to be repaired. You can’t take the money from the security deposit while the tenant is still living there to pay for repairs. The onus of the repair might be the landlord’s or the tenant’s depending on the terms of the lease. If it’s the landlord’s responsibility, you pay for the repair using your rental business account. If it’s the tenant’s responsibility, they must pay for it from their own account.
• Use the security deposit to pay for normal wear and tear of the property. If the usage of the property falls within the normal wear and tear then we cannot, as the owner and/or landlord, use the security deposit to reimburse ourselves for that cost. For example, if you hire a contractor to lightly clean the unit after the tenant left, you can’t bill the tenant for the cleaning fee. Why not? You would have done the cleaning between tenants anyway. It’s part of doing business as the landlord and property owner of a rental property.

Now, if the tenant moved out and during pre-move-out inspection, you notice a big hole in the wall that needs to be repaired, the cost of the repair can be deducted from their security deposit.

• Comingle the security deposit with rental income funds. The security deposit must be kept in a separate bank account (aka security trust account) from the operating trust account which is used for rental income and operating funds. Most states mandate a segregation of funds between rent and security deposits, entitling tenants to any accumulated interest in the security deposit account. Again this varies from state to state. Make yourself familiar with the rental property laws for your particular state. If you consider that the security deposit is technically the tenant’s money and not yours, you should be in good shape.

Can Security Deposits be Used to Cover Back Rent?

The security deposit is not a proxy for last month’s rent and for very good reason. Tenants that are on a twelve month lease and the last month of occupancy, often say, “Just take my last month’s rent out of my security deposit.” Not so fast!  At Haven Homes, our lease specifically states not to use the security deposit for the last month’s rent.

Why? It puts the landlord in a really bad spot if the tenant moves out with a rental balance and they damage the property. Essentially, you must try to collect the money from the tenant after they’ve moved out. When that’s the case, there’s always the risk that you won’t be able to get the money owed you.

If you allow a tenant to move-in to your property without paying the security deposit, you are leaving yourself financially vulnerable. If the tenant causes damage or stops paying their rent, you no longer have access to funds to cover these expenses.

Make sure to consider each tenant and their particular circumstances on a one-by-one basis when it comes to charging a security deposit. Don’t fall into the “one size fits all trap” of always securing an additional one month’s rent as a security deposit. For some tenants, it makes better sense to charge two months if their past rental history dictates.

Most importantly, always check the landlord/tenant state laws and regulations for your state. Laws and regulations are imposed on a state level, not a federal one. As such, there are slight differences and variances among states that could get you in hot water if left unaware. Two great online sources are Landlordology and the Landlord Protection Agency.