Today, I’m going to walk you through all the important stuff that you need to know about security deposit.
It’s a common term in the world of real estate, but its underlying principles can be a little confusing, especially for those who are new to the business. They vary from state to state and are subject to legal interpretations.
In this no nonsense guide, I’ll cut through all the noise and BS so you can have a sound understanding of the topic.
So, what is a security deposit?
In a nutshell, it’s a one-time payment made to a landlord as proof of intention to move in and take good care of a property. The landlord collects it on top of the tenant’s first month’s rent.
It’s not required by law and it’s appropriately called ‘security’ deposit as it protects landlords financially. In fact, it’s one of the most important lines of defense for landlords.
For instance, if you’re the landlord and your tenant causes damage or leaves without paying rent, you have the right to take the deposit.
As a landlord, there are 5 basic principles that you MUST know understand about security deposits. The first is the deposit limit.
1. Deposit Limit
24 states in the US don’t impose statutory limits on security deposits. The rest limit the deposit to an amount between one month to three-and-a-half months’ worth of rent.
Once paid, you can either deposit the money in a bank (usually separate from your personal account) or in a cash bond. The latter assures the tenant that there’s money available to repay their security deposit.
One more thing—you must notify your tenant about where their security deposit is being held.
Important: Cities and counties can also impose limits on security deposits. Hence, you must be aware of the local ordinances regardless of the state where you own a rental property.
Knowing the legal limits is important, as is having a good understanding of the local market. Consider this: if other landlords in your area are requiring a one-month deposit for a comparable property, you’re likely going to lose prospective tenants by demanding a two-month security deposit.
It is a safer bet to match the prevailing amount charged in your market than to risk extended vacancies. No tenants means no rentals—you do the math.
2. Security Deposit Due Date
This must form part of your agreement with your tenant. Set a specific date and collect the whole amount before they move into the unit. If the tenant fails to pay the full amount upfront, you have the right to cancel the lease and have the unit open for rental to others.
Make this your standard practice and never allow a tenant to move in if they haven’t paid the security deposit. In the rental property business, it always pays to play it safe.
3. Holding the Security Deposit
Some states don’t specify where you must keep the deposit, but others like Massachusetts require you to keep it in a separate, interest-earning bank account. Each account must clearly indicate that it contains funds that don’t belong to you and are simply being held in escrow for your tenant.
Important: As a landlord, you must remember that the security deposit remains a property of the tenant until you are authorized by law to use it.
Some states also require you to provide a receipt within 30 days of move-in. The receipt must indicate the following:
- The name and location of the bank where the deposit is being held
- The account number
- The amount of the deposit
- The annual interest rate
If you don’t hold your tenant’s security deposit in the correct type of bank account or if you fail to provide the required receipt, you lose the right to keep the security deposit. You may also be subject to punitive damages if a tenant sues you to reclaim the deposit.
The law provides a lot of protections to both landlords and tenants. Make sure you follow all legal requirements and don’t take unnecessary risks otherwise you’ll end up on the losing side.
4. Returning Deposits
Every state has laws specifying how much time you can wait before either returning the security deposit or explaining the reasons for keeping it.
Some states set the limit at 15 days following the termination of the lease, while others allow up to 30 days to return the deposit or give your tenant a written notice explaining why it wasn’t returned.
Note that there are 4 common instances when you don’t have to return a tenant’s security deposit. They are as follows:
- Early Termination of a Lease
- Non-payment of Rent
- Unpaid Utilities
- Damage to Property
If your tenant breaks their lease, you can keep all or part of the security deposit to cover the expenses related to this breach.
Again, this will depend on the terms in your lease, as well as the landlord-tenant laws in your state.
If there is an early termination clause in the lease, the tenant will have to abide by it.
Most states allow you to keep the security deposit if your tenant doesn’t pay their rent. In fact, it’s a breach of the lease!
When your tenant fails to pay their monthly rent, you are allowed to keep all or a portion of their security deposit to cover the lost rent.
Let’s say you have a tenant that moved out without paying for all their utility bills. In this case you can keep the security deposit to cover the cost for any utilities they failed to pay and were required to pay as stated in the lease.
Your tenant may not be entitled to the return of their security deposit if they caused damage to your property.
Note that there is a huge difference between damage and normal wear and tear. Below are some examples of each:
Normal wear and tear: a few small pinholes in the walls, furniture marks in the carpet, tarnish on bathroom fixtures, faded paint or wallpaper due to sunlight, warped doors caused by age, moisture or temperature; broken plumbing caused by normal use, and reasonable amounts of dirt, dust or grime on the appliances, walls or floors
Damage: multiple huge holes in walls, broken doors, broken windows, broken tiles or fixtures in bathrooms, clogged toilet due to misuse, missing outlet covers, missing smoke detectors, appliances broken by neglect, cracked bathroom or kitchen countertop, excessively filthy bathtub, toilet, shower or sink
5. Keeping Deposits
We can’t emphasize enough that the security deposit is a form of insurance for landlords. It protects against breach of lease by your tenant.
While the state allows you to sue a tenant for a certain amount that they owe you, it is tough to collect the money even if you win the legal battle. The security deposit provides a buffer for the loss of cash flow.
If you have a lawful reason to keep the security deposit, document the problem and provide a written explanation to your tenant within the state's allotted timeframe.
Sometimes, you will only be able to keep a portion of the deposit and return the rest. For instance, if the security deposit was $1,100 and you estimated $600 worth of damage, you’ll need to return $500 and provide a written explanation as to why you kept the $600.
As you can see, security deposits can be tricky. Taking the security deposit for granted is one of the biggest mistakes that you as a landlord can make. By following the simple guidelines outlined above, you can avoid the common pitfalls. Security deposit is money in the bank—until you need to give it back.
At RentDrop, we help landlords make property management simpler and easier by allowing them to collect rent and security deposit from their tenants online, instead of relying on paper checks. Sign up now and make sure to leave a comment to let us know what you think about this post.