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5 Factors That Determine Appropriate Security Deposit Amount
So you have finally officially become the owner of a rental property and consider yourself a landlord.
You have setup the property for rental and have found a tenant who meets the profile of the type of tenants to rent to.
With a little give and take, you have finally agreed on a rental price with the tenant.
Now what’s left are formalities.
And… what about the security deposit?
A lot of landlords assume that the amount of security deposit is a multiple of the monthly rental. Some work with 2 months worth of rental while many go with 3.
While there is nothing wrong with such practice as long as all parties agree to the amount, there can be times when tenants feel that the deposit is unfairly high. Even landlords can sometimes feel that tenants’ expectations are unfairly low.
Knowing what are the factors that determine a fair security deposit amount can help all parties agree on a fair value and prevent conflicts in future.
Here are some key factors that determine security deposit.
1) Refundable and non-refundable deposit
This might be something new to you if you are new to the landlording business.
The deposit can come in 3 forms:
- Fully refundable
- Fully non-refundable
- A combination of both
Seldom will you find tenants who would agree to a fully non-refundable deposit. It would be like giving the landlord free money.
As you might expect, tenants would lean towards refundable deposits while landlords would prefer non-refundable deposits.
This is why it is common for parties to settle for a combination of both. Meaning a deposit that consists of a portion of both.
Before going ahead with a nonrefundable deposit, take note that certain states do not allow such practices. And some have a ceiling of how much it can be.
Just be mindful that even if your property is located in an area that allows for non-refundable deposits, applying them to your lease can harm your business when competing landlords in the area do not require such deposits.
2) Monthly rental
The higher value a piece of real estate is, the higher you can expect market forces to push rental upwards.
It’s just the way demand and supply has a effect on prices.
And the higher the rental, the higher you can expect the security deposit to be.
It makes little sense that an apartment in the city with a monthly rental of $5,000 only carries a security deposit of $2,000.
Even if it is a legitimate deal, it might look too weird for prospecting tenants to inquire about.
3) Rental market
From the previous point, the monthly rental with pay a huge part in determining the amount of deposit.
This implies that the demand and supply in the rental market that can greatly affect the rental of homes can indirectly affect the deposit too.
High vacancies will push rental lower while high take up rates will spike rental upwards.
This will nudge deposits accordingly up or down.
4) Property condition
If a house is considered a luxury property furnished with designer brands and upmarket building material, it is only logical for a higher deposit since it would cost more for repairs and replacements.
This means that a home that is put together with the bare minimum of living essentials will result in a lower deposit.
Good luck convincing a tenant to part with a high deposit when your rental property just consist of novelty furniture and fixtures.
5) Local law
You might not have a free-hand dictating the amount of security deposit you can request.
Some state have very rigid laws concerning the amount of deposit a landlord can demand from tenants.
Make sure to check the local laws in the area to avoid unknowingly violating them.