Posted almost 2 years ago

Why Use Tenant Holding Fees Instead of Earnest Deposits?

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Have you ever had an applicant enthusiastically agree to rent your property, only to back out a day before signing the lease? Or your potential tenant suddenly announcing that they have a German Shepherd when you specifically said "no pets"? It's a waste of landlords' time and highly aggravating, to say the least.

Now, imagine if this happens when your property is in a high-demand rental market, and you have multiple applicants all vying to secure your place. An applicant who falls through the last minute is more than just a waste of time in this situation--it's a waste of potential income.

Not all landlords do this, but there is a solution to protect yourself in these situations, especially in competitive markets where properties get multiple applicants.

Setting up a Tenant Holding Fee Agreement lets serious applicants show their commitment to renting your property. If the applicant doesn’t cooperate, landlords can benefit from the ability to quickly offer your property to other potential tenants waiting in the wings.

Here's a quick guide on how to set up Tenant Holding Fees in your rental business:

What is a Tenant Holding Fee?

A Tenant Holding Fee is an amount paid by prospective tenants to "reserve" the property as their application is processed. It's similar to an Earnest Money Deposit (EMD) that you'd put down to show good faith before sealing the deal on a home purchase. Similar to an EMD, it is nonrefundable unless specific conditions are met.

In our experience, a lot of applicants think that applying for a property does reserve it for them, but this isn't actually the case, so spelling out the terms of the Holding Fee in your marketing should make it clear that this is the only circumstance under which a property will be held for them and a late MoveIn date.

Why are Tenant Holding Fees Important?

Many real estate agents and property managers don't use Holding Fees or EMDs for leases at all, because they don't think it's worth it. Since the lease will be signed in a short time, they think "our tenant isn't going to back out!" But can they guarantee that? No. So, that's where the Holding Fee comes in.

Why use a Tenant Holding Fee instead of an EMD?

It's better to call it a "Holding Fee," rather than a deposit, since the word "deposit" tends to imply it's refundable, which Tenant Holding Fees are not (except in specific circumstances).

We've lost 2 court cases where applicants backed out at the last minute, and in both cases, the courts made us return the money, just because it was called a deposit. They never got to the point where we showed that the tenant had violated the agreement or changed their mind about the property - they just decided that deposits are always refundable. That’s why we recommend calling it a Holding Fee instead.

What are the Benefits of Tenant Holding Fees?

Holding fees create a win-win situation for both the tenant and the landlord, because they:

(1) Assure the tenant the property they want is theirs, once they complete the screening requirements,

(2) Motivate the tenant to hurry and complete their documentation submission or risk losing the property,

(3) Protect the landlord from losing too much time & money if the tenant suddenly bails,

(4) Create a buffer time for the landlord to check everything before lease signing, and

(5) Remove any uncertainty over whether or not the applicant has reserved the property.

Common Questions about Setting Up Tenant Holding Fees

  1. How much can I charge?

Generally, the Holding Fee is equal to one month’s rent, but can be any reasonable amount.

We go for one month, because then the Fee functions almost like a screening criterion - if they can't come up with 1 month upfront to hold the property, then how will they come up with the first month's rent and security deposit?

Just be sure you have a Holding Fee Agreement that very specifically spells out when the Holding Fee may be refundable, with deadlines.

  1. How long should the Holding Fee Period be?

The amount of time the Holding Fee is valid for depends on the applicant's desired Move In Date, but be careful if they’re holding the property for over 2 weeks - in this case, you may be able to find someone else to rent it sooner.

A 2-week Holding Fee Period gives applicants enough time to sign the lease and submit additional funds due. You should try to get a lease signed as early in this process as possible, even if it doesn’t take effect for another few weeks.

Once the Holding Fee Period is up, aggressively start looking for a new tenant or better yet, go with a backup. You can have pre-approved tenants waiting on a list to rent the property if the Holding Fee applicant goes beyond this deadline. If one of them signs the lease first, then the original applicant will lose out on the rental.

  1. What information do I need to provide?

When setting up a Tenant Holding Fee, the minimum details you should give to the applicant are:

  • - The total amount that’s required to hold the property temporarily
  • - Any additional screening requirements they need to fulfill
  • - Any additional funds due and when they are due by
  • - The circumstances in which the fee is refundable (and when it’s not)
  • - A copy of the lease
  • - A specified deadline for the Holding Fee Period
  1. Can I collect multiple Tenant Holding Fees at once?

You can collect Holding Fees from backup applicants on your waitlist, as long as you disclose that this is only a backup, in the event that the original applicant falls through. The backup's Holding Fee will only kick in once the original one expires, and their Fee is fully refundable if the first applicant does push through. This is particularly useful if there's a waitlist for a property, and one of the wait listers wants to jump to the top of the list - they can offer a backup Holding Fee to do this.

  1. When does the Holding Fee have to be refunded?

This is technically up to you and what the local market will bear. Keep in mind the purpose of the Holding Fee is to get applicants/prospects to commit. If they don’t perform and the landlord/owner loses rental income, the Holding Fee can be held to compensate. So, there are a few scenarios wherein we feel obligated to refund a Holding Fee and they are spelled out in our Holding Fee Agreement:

Applicant Fails Screening

Usually, the Holding Fee is collected after a tenant has already gone through the screening process successfully. However, sometimes, on hot properties that are getting a lot of interest, applicants choose to pay a Holding Fee when they submit their application. They want to hold the unit pending their application being processed and approved.

In this situation, set a clear deadline for them to cooperate with the screening requirements, so you’re not holding the property indefinitely. If they fail screening, their Holding Fee should be refunded.

Unit Fails Section 8 Inspection

If you accept a Holding Fee from an approved applicant, but the property fails the required Section 8 inspection, then it only makes sense to refund the Holding Fee as the applicant has done nothing wrong.

No Loss or Limited Loss of Rental Income

If the applicant voluntarily withdraws from consideration and you can quickly find another applicant to move in on the same date or soon after, you may have to refund all or a prorated amount of their Holding Fee.

For example, if they wanted to move in on Sep 1, but they change their minds and go with another property, then you’re able to find a replacement who moves in on Sep 10. In that case, you may want to refund all but the prorated 10 days of the Holding Fee paid by the initial applicant. 

Check your state laws, as several won’t allow a landlord to collect or retain “rent” from two tenants covering the same time period.

  1. What happens when the lease is signed?

The Holding Fee is technically a non-refundable fee; therefore, it technically should not be considered rent or a security deposit. Some PMCs may charge it to the applicant as a fee and not credit to the lease. Others credit the full amount towards the total Move In Funds (first month’s rent + security deposit).

Offering a Holding Fee gives landlords little to lose, but much to gain.

This is especially relevant in highly competitive real estate markets, like Metro Detroit, where rentals frequently receive multiple applicants at a time. Tenant Holding Fees don't prevent applicants from backing out at the last minute, but they help minimize the chance of this happening, and help reduce the amount of rental income landlords lose when they do.

Would you consider setting up Tenant Holding Fees for your rentals? Why or why not?

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