What Rental Property Owners Should Know about Security Deposits

Real estate investors who own rental income property and therefore deal with tenants, have to consider at least the following five things about security deposits before they sign their next rental agreement.

1. The amount of the deposit 2. When the deposit is payable 3. What rate of interest, if any, will be paid on the deposit 4. What conditions warrant when tenants will forfeit all or part of their deposit 5. When the deposit will be refunded if tenants satisfy all terms of the lease

These important issues must clearly be spelled out to tenants in the rental agreement. The last thing you want is legal action with a tenant, so be sure to craft a security deposit policy that openly addresses every issue.

Let's look.

Amount of the Deposit – Numerous investors prefer high security deposits along with the first and last month's rent because they prefer renting to tenants with a substantial financial capability. You may discover, however, that your tenant segment doesn't (or can't) meet this requirement. Therefore, you might want to research what other property owners in your area are doing and tailor your security deposit policy accordingly.

When the Deposit is Payable – Property owners usually prefer to make the deposit payable in advance. It's commonly accepted that you would just be asking for trouble if you allow tenants to pay their deposit piecemeal over several months. The popular notion is that it's always smarter to collect the deposit up front, before the tenants move into the unit.

Interest on the Deposit – Even in those cases where local and state laws require owners to pay interest to their tenants for security deposits, some owners pay interest to their tenants even if the law doesn't require it. It might not be a big issue when interest rates are low, but it can otherwise comfort tenants who have to pay larger deposits.

Forfeiture of the Deposit – Always make sure your tenants understand your deposit forfeiture policy before they take possession of your unit, and always, as soon as the tenants have vacated the unit, perform a walk-through inspection of the unit with your tenant.

Here are several ways owners commonly handle deposit forfeitures.

Some develop a schedule of costs with a clear-cut amount per correction such as $40 for broken windows, $60 for holes in the wall, $35 for dirty appliances, and $125 for general cleaning. Others levy actual costs after the remedial work has been performed, and some simply try to keep the full security deposit as liquidated damages even when the actual damages fall substantially below the amount of the security deposit (not recommended).

No matter which approach you take, though, be sure to conduct a final walk-through as soon as possible. Never let too many days pass between the date tenants move out and the date you inspect. Always have the tenants present with you during this inspection, and always have your inspection sheet (the one prepared when the tenants moved into the property) so you can compare the property item by item.

One final thought about forfeitures. When signing the rental agreement, tenants should understand that the security deposit does not limit their liability for rent or damages. If their actual damages exceed the deposit, they must acknowledge that they will be required to pay the higher amount.

Return of the Deposit – To protect your image, you should return security deposits with interest back to the tenants as soon as you know the correct amount (perhaps at the end of the final walk-through). It sours tenant relations (and may even subject you to legal penalties) to delay returning security deposits without cause.

Here's the bottom line.

It's important to understand what might constitute a good security deposit policy and begin to implement it because some tenants have little regard for the investor's property. You might not avoid deadbeat tenants by implementing a stern security deposit policy, but it sure can help to safeguard your investment.

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