What Is a Security Deposit?

A security deposit is an amount of money required by a landlord from a tenant before move in. A security deposit acts as a guarantee against property damages. Most of the time, security deposits are refundable—assuming there are no significant damages when the tenant moves out. In some cases, security deposits may be non-refundable, as in the case of a pet deposit or a portion of the security deposit that gets applied to the last month’s rent. 

Security deposits should be outlined in the lease agreement. The renter should be aware of exactly how much money is required as a security deposit and under what circumstances the security deposit will not be refunded to them. The rental agreement should also spell out when an increase in the security deposit would be needed and by what amount. 

Why Require a Security Deposit?

As a real estate investor, you should always require your renter to pay a security deposit. It’s a type of good faith insurance policy letting you know that the tenant will take care of your property. After all, the tenant wants their security deposit back when they move out! 

Any damage beyond normal wear and tear can be deducted from the security deposit. This includes tenant-caused damage to the walls, flooring, windows, appliances, cabinetry, screens, and systems. Not all damage can be applied to the security deposit, though. Damage caused by failed systems or acts of nature are not the fault of the tenant and therefore cannot be charged against the security deposit.

For example, if a branch falls through the roof during a storm, you cannot deduct the cost of repairs from the security deposit. But if the tenant puts a hole in the roof by trying to install an unsanctioned satellite dish, those repairs can be charged against the security deposit.  

Rules for Returning Security Deposits

Each state has different time limits dictating when a landlord must return the security deposit to the tenant, so be sure to check the laws in your state. Return dates can range between 14 to 75 days, depending on the laws and circumstances.

When collecting the security deposit, landlords should do an initial walkthrough with the tenant. At that time, tenants should make note of anything that is broken, scratched, or otherwise damaged to avoid being responsible for pre-existing blemishes. Both parties should sign the walkthrough document and retain copies. Time stamped photographic evidence during the initial walkthrough can also guard against discrepancies later. 

Before returning the security deposit, landlords will do a final walkthrough. In many states, the tenant has the right to be present for this final walkthrough. During the final walkthrough, landlords will use the initial walkthrough document as a baseline. Any additional damages can delay or diminish the security deposit. Cleaning fees might also be deducted from the security deposit if the tenant vacates the property without returning it to its original state of cleanliness. 

Landlords need to keep thorough records about the condition of the property, because the law regarding security deposit returns is on the side of the tenant. You don’t want to end up in small claims court over a security deposit dispute. If a judge rules that you withheld a security deposit unnecessarily, you could be on the hook for up to three times the amount of the original security deposit—unless there’s objective and irrefutable evidence that the tenant caused the damage.

In addition to damages, landlords may also be able to use the security deposit to recover late fees and unpaid rent (laws vary by state). However, this scenario is not ideal for landlords, as the security deposit may not be large enough to cover both unpaid rent and damages. Landlords should try to recover rent and late fees first and fall back on the security deposit as a last resort, if lawful in your area. 

How Much Security Deposit Should I Ask For?

On average, the typical security deposit is usually set at the equivalent of one month’s rent. But security deposit amounts vary based upon state and local norms, with the range running between half of one month’s rent up to the equivalent of three times the monthly rent. 

The landlord has the right to determine the amount of the security deposit, within certain state enforced limitations. For example, under most circumstances in California, a landlord may not ask for a security deposit that exceeds the equivalent of two months’ rent for unfurnished properties or exceeds three months’ rent for furnished properties. Be sure to check the state laws before setting the amount of your security deposit.

Landlords should also be aware of any local ordinances and best practices in regards to security deposits. Certain rent-controlled areas may have additional limitations regarding the amount of the security deposit. Also, if you wish to set your security deposit at the equivalent of two months’ rent while most landlords in your neighborhood are requiring the equivalent of one month’s rent, you could find yourself limited in tenant applications and suffer higher vacancy costs while waiting to place an appropriate tenant.

After consulting state and local laws, landlords should determine their own security deposit amounts based upon what they have to lose at a particular property. For instance, a rental unit outfitted with state-of-the-art appliances and high-end wood flooring has the potential for more loss from damages than a unit with second hand appliances and linoleum flooring. Consider the worst-case scenario and set your security deposit amount appropriately.   

Security Deposits and Escrow Account Laws

Some states require security deposits to be kept in a separate escrow account. Escrow accounts are neutral bank accounts used solely for the purpose of holding the security deposit. Escrow accounts keep the books clean, verifying that the security deposit was not used for any other purpose than what was previously designated in the rental agreement.

To go one step further, some state and local laws mandate that security deposits be held in interest bearing bank accounts and stipulate that upon termination of the lease agreement the tenant is entitled to the interest accrued. 

Security deposits are a necessary part of the landlord/tenant agreement. With proper forethought and implementation, a security deposit can be advantageous in protecting your property against tenant-induced damages.

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