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Why Security Deposits Are Unique And How To Handle Them
Security deposits are not rental, they are definitely not an income, and you must be hepped up on goofballs if you book it in as profits for year.
New landlords often make the mistake of classifying them as a sort of expense fund or a petty cash fund. Not realizing that doing so can have legal implications should tenants pursue the matter. And that is every likelihood should your landlord-tenant relationship deteriorates like leftover food.
Don’t forget that the deposit is not a fee. If you do charge a non-refundable fee for whatever reasons (evil you :D), make sure to mention it in black and white in the tenancy agreement.
Other than being a cash deposit (obviously), it is a form of guarantee that the tenant undertakes for complying with the terms of lease, and the return of the property in it’s original condition when they move out.
The purpose of a security deposit is to deter tenants from bad destructive behavior that will negatively impact the landlord financially.
Because it is a deposit made by the tenant, the money legitimately belongs to the tenant.
Different markets, countries, and states may practice this differently. But usually the gist would be the same. Misappropriation of the funds can be illegal.
You should check the local laws regarding security deposits whenever you are unsure.
Collecting the deposit
The security deposit is usually collected together with the first month’s rental. Although this is common practice, it is also not ideal.
As collecting the rental usually means that the tenant is moving in really soon, if not already.
Should the check bounce, you will be left with no deposit, no rental, and an active tenant to deal with. This will be a completely different, and more complicated situation to deal with compared to someone who has yet to officially become a tenant.
You might now have to enforce eviction processes… without even an extra penny in your bank account!
This could be a good justified reason for you to only accept cashiers orders, banker’s guarantees, or some sort of guaranteed funds for security deposits.
However, tenants usually have an overwhelming preference for checks. So you have to made a decision on this one.
And to avoid confusion, you might even want to receive the deposit and first rental in different check payments in full.
Finally, NEVER allow payments to be made in installments.
How much of an amount?
The popular practice in many developed real estate markets go with 1 month worth of rental as the security deposit. But do note that this is not a legal standard. Just use this as a guideline.
The landlord pretty much determines the amount within the limits (f any) set and permitted by local laws.
So if you are a very persuasive person and can get the tenant to fork out 2 months worth of rental as deposit, there is nothing stopping you from doing that… unless it’s over the statutory limit.
As mentioned in the previous point regarding collection, you should at least collect the equivalent of 1 month rent.
Consider segmenting the deposits
It’s no coincidence that the longer you have become a landlord, the more meticulous and complex your business systems can become.
As you slowly grow into a veteran landlord, you’ll start to experience for yourself weird issues that cause friction and confrontation with tenants. And many of these problems can be resolved in your favor if there was better documentation.
This is why many landlords break up deposits these days. Some might see this as old-fashioned and so much more hassle. I belong to that category of observers. But I also have to admit that such segmenting can make a huge difference should some specific issues arise.
It doesn’t mean that a lack of segmenting deposits will cause you to lose a challenge from a tenant. It just means that it might take a little more effort to swing things in your favor.
I also don’t like the notion of having lower limits on specific items caused by segmenting.
If you do like the idea of breaking up and categorizing deposits, here are some categories to think about:
Don’t forget about the laws in your state
Although the main points concerning security deposits are more or less the same, there can be little legal details that are very different from state to state.
And if you are watch any TV at all, you will know that even the smallest clauses and footnotes can have huge legal implications.
So do remember to make a visit to the local authorities to find out and make sure that whatever you are doing, or intend to do, regarding security deposits fall in line with the laws of the land.