The True Importance of a Security Deposit

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Yes, you are welcome to call me Captain Obvious on this one. While I feel like this notion is extremely apparent, it actually wasn’t to me until recently. Therefore, I think it is worth addressing.
In my case over the years, I have moved in numerous places where I pay “x” amount of a security deposit and when I move out however many years later, I get the same “x” amount of security deposit back. Simple. I wondered every time that process occurred, “What is the point of even putting it down in the first place when I just get it all back?” I think I knew the point, which was so any damages incurred by me would be covered, but those damages never realistically happened so I just figured it was merely a paperwork process of sorts that needed to be done.

Then I became a rental property owner. Good grief to the universe above! Tenants can seriously be pains in the… I’m sure I don’t have to say it. I use the example all the time of the property I have that went through two back-to-back evictions. I can unfortunately add to that story now and tell you that the perfectly good tenants most recently in there apparently took a job offer elsewhere, left the house mid-lease, and didn’t tell anyone until well after they were gone. Fan-friggin-tastic. Three sets of tenants in a row in that house! I truly never realized the true impact of abysmal tenants on my checkbook. I digress.

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The Value of the Security Deposit

Sadly, it has taken me four bunk tenants (three from the house above and now some tenants from another property) to realize how important a security deposit really is. Even when the first couple tenants’ security deposits were being used towards turnover expenses, I still wasn’t connecting the dots with the value of that money. I’ll tell you what I always had in my head about security deposits, and then I’ll tell you what I realize now about security deposits and I think you will see the distinction.

What I used to understand about security deposits-

The money a tenant puts down for a security deposit will help me pay for any damages they cause.

What I now understand about security deposits-

Whatever money a tenant does not put down for a security deposit has to come out of my own pocket!

Translating both of these to a real-life scenario should really drive this home. A tenant puts down a $750 security deposit.
Translation of my old thought process about security deposits-

“Yay! If anything happens to the house, I have $750 of free money to use towards fixing it! Yay!”

Translation of my new thought process about security deposits-

“Oh, uh uh, only $750 of free money? You must be kidding me. That leaves me with $1250 of expenses I have to cover! Uh uh. Not okay!”

See the distinction? So far no turnover from bouncing tenants has cost me less than $2400 (which is very much related to my irritations with property management because that never should have been the case). Even the example above is more generous than reality saying I only had to cover $1250 since in actuality it has been more like $1650, if not more!

Moral of the Story?

Don’t skimp out on security deposits! They may end up being the only thing that keeps any money in your pocket. Whatever you don’t charge, you will have to pay yourself.

A Good Thought

… and one I had never thought of myself. I recently moved into a new place in Venice Beach. Granted, it’s the most I’ve ever spent for rent in my life (and the place doesn’t even have a kitchen), but for that area I’m considered to be paying a “low rent”.

The owner of the building requires anyone in the “low rent” category to pay a TWO months security deposit. Holy kidding me! I gawked at the worthlessness of me having to pay that much out of pocket just to move in and not seeing that nice amount of money until I move back out. Not a day later I found out about some new expenses the tenants who left one of my properties were now costing me, and suddenly the light bulb went off. My now-landlord is the smartest man on the planet! Charging two months’ rent as a security deposit has him doubly, if not more, covered in case I’m a heathen and rack up the damage and move out leaving him with a major vacancy. What a smart man!

I’m truly considering the feasibility of charging my tenants from here on out double the normal security deposit. First of all, it will disqualify a lot of riff raff who don’t have that much money, but it will then cover me so much better for turnover expenses should I have them! Whether I end up doing it or not, I’m not sure yet, but the point is to highlight the option of actually charging more than standard for a deposit. My landlord only does it for the “low rent” tenants (like myself, haha..) because typically they are the ones who walk out and/or cause damage, versus the ones paying thousands of dollars each month in rent as they tend to be a little more caring of the property. So you may not want to do that for all of your tenants, but depending on the applicants and/or the property or area, you might want to consider it!

Anyone else have any other Captain Obvious thoughts they care to share about covering yourself for tenant mishaps?

About Author

Ali Boone

Ali Boone(G+) left her corporate job as an Aeronautical Engineer to work full-time in Real Estate Investing. She began as an investor in 2011 and managed to buy 5 properties in her first 18 months using only creative financing methods. Her focus is on rental properties, specifically turnkey rental properties, and has also invested out of the country in Nicaragua.

22 Comments

  1. I guess going to small claims court to collect the amount owed for damages less the deposit will cost you more money and time than it’s worth?

    If I rent a single family home for $1000. Get a $3000. for a security deposit. Do you charge for lasts months rent? as well?

    so total would be:
    $1000 1st months rent
    $3000 security deposit (3months rent)
    $1000 last months rent

    $5000 total

    • Ali Boone

      Hi Mark, thanks for commenting! I don’t usually worry about collecting a last month’s rent if I do double the security deposit. And remember too, I think this method is better used on some properties than others. For properties in high demand, I think it makes total sense because it can help you sift through the tenant pool and seek out the better tenants. If there isn’t a lot of demand, you have to weigh the impact of requiring so much money upfront (is waiting for a tenant who can pay that much going to take four months instead of one month, meaning you lose out on three rent payments in attempt to save money?).

      As far as going after the tenants, my property managers always file the claims but I’ve yet to have ever seen any money out of it. You can’t get money from someone who has no money, unfortunately.

  2. Brandon Turner

    Hey Ali,

    Sorry about that crappy cursed rental! I do wonder how much of that is the property manager? I know you’ve talked a lot about that too.

    As for security deposit – I love the way you phrased it “Whatever money a tenant does not put down for a security deposit has to come out of my own pocket!” – So true! I even take it one step further and say “whatever money a tenant does not put down for a security deposit is money they are reaching into my wallet and stealing from me!”

    I currently charge a security deposit for everyone (of course) and if there is ANYTHING questionable in their background I will charge a double security deposit. I’ve never charged “last month’s rent” but I’d consider that as well.

    Maybe your next post can be “How I fired my property management?” 😉

    • Ali Boone

      Hey Brandon! OH, I blame 99% of that property’s woes on the property management that was (keyword ‘was’) running it. I had my reasons for keeping that management company as long as I did, but in hindsight I should have ditched them a long time ago. Haha… I love that article idea! I may just have to do that 😉

      Great input actually that I left out of my article. Any blemishes on a tenant’s application most definitely should encourage you to charge more for the security deposit! Absolutely and don’t back down on that. I have some tenants now who had an eviction blemish from years back and my property manager, because of that eviction, got them to pay $1325/month instead of $1000/month in rent! It gives them a chance despite the blemish but helps protect me a little more as well. So far it’s worked out nicely.

  3. Steve Toohey on

    Ali, you stumbled into the most important aspect, at least as far as I’m concerned…”it will disqualify a lot of riff raff who don’t have that much money.” Although I might not phrase it quite so bluntly, I would say that if someone can’t cover the first month, the full deposit, and the pet fees right up front, they are probably going to be the source of many headaches down the road. I also like the idea of a significant rent pre-payment if credit is a concern (and it really seems to be these days for most tenants).

    • Ali Boone

      Steve, I agree 100%! I understand that a lot of tenants probably do live paycheck to paycheck, and I want to be accommodating to their financial situations, but you are right, if they don’t have at least the deposit, a month’s rent, and pet fees… it’s only the start of the headaches, even if they are only late payments instead of no payments. Late payments every month is a huge headache. Plus, it’s also a sign that the rent payment may be a little too high for them, which increases the risk of having to evict them later or them walking away from the property.

    • Peter Mckernan on

      Hey Steve,

      I am wondering how much you charge your tenants for pet fees and if you make them pay for all utilities except lawn maintenance. Thanks in advance.

  4. I think security deposit is very important but even more if you do not manage the properties yourself. Also if you do manage yourself you must be very proactive. I purchased a couple properties with tenants in place and several had very low security deposits. The same tenants are still in place 2 years later. I have made some upgrades as well as minor repairs here and there. The biggest thing for me is that I get to see my properties at least once a month so can act on things or work on problems spots at least with most tenants.

    I also think that a lot of this business has to do managing the float. If you have damages above the security deposit amount, you can always collect that from the tenant. If not willingly, then through the courts. Just have to have good notes.

    • Ali Boone

      Kyle, good input. It definitely helps to have an eye on any property monthly. Even if I’m not local to do that, a property manager should do just what you do. My favorite property manager does that on my properties. He tells the tenants it is a monthly “home inspection” where he’s checking pipes, filters, etc. and while he does actually check those things, he is really eyeballing the tenant.

      I do have to disagree though that you can always collect the extra money from the tenant. I’ve never succeeded in doing that so far. By the time you have to use their security deposit for something, they are already gone from the house and could care less what money you tell them they owe. As I mentioned in a comment above, you can absolutely get the courts involved but even if they support you, you can’t collect money from someone who has no money, which is the likely case if they left the property in that fashion.

      • That is awesome that your new property management company does that. Definately well worth the cost for such excellent service.

        I havn’t had much for vacancies during my career but one that I asked to leave because of some issues that they failed to resolve had some damages above and beyond the security deposit. She failed to respond to my requests for damage costs. I told her the date I was going to file for court action and then did. We went to court got a mediator as court standard. I gave her the same deal I would have offered if she would have talked to me outside of court but then added the court costs to this. She actually paid out over the next 8 months as agreed to. She really could have stopped and put me on the waiting list to garnish her wages. I was sort of surprized but it worked for me. I do worry if I have a self employed tenant as there is little to garnish but that goes into the offer and terms of their rental agreement.

        Thanks for the response, keep up the good work.

        • Ali Boone

          Great comment Kyle! It’s great to give personal experiences so other people can learn from them. You definitely lucked out, both with no vacancies and getting paid out by the one! So awesome! But yes, it goes to show that it can be very hard to go after tenants who already didn’t care to take care of the house or pay the rent in the first place.

  5. Andy Teasley on

    OK here’s the view from the other side of the tracks. The low cost rentals I own get rented to working class people who can’t afford a bigger place in a nicer neighborhood, as such, getting together two month’s rent is a problem for them. Since we needed to fill a large number of empty units as we were finishing them in 2009, we started renting with a free month’s rent with a 12 month lease, this allowed new tenents to move in with only one month’s rent.

    I was listening to an interview on Bruce Norris’ pod cast one night when I had had 3 good tenents move out and an eviction as well, so I was under a cash strain. Shawn Watkins has low end rentals in Utah and he was discussing his leasing policies, he charges no deposits and has no leases. Sounds hard to believe right? He said he tells the tenents ‘if you need to move just give me 30 days notice and let me show the unit and then go and if I want you to move because we don’t work out I’ll give you 30 days notice too and then you can go. Since I’m not charging you a deposit I’ll need you to sign this agreement listing what you will pay to make these repairs if you leave this damage and you are responsible for any repairs the unit needs while you live here, up to $150.’

    I thought about what he said and we started using this system 6 months ago, so far the good tenents are great and the bad tenents are still bad. But we are able to charge above market rents and our good tenents don’t leave us repairs saying ‘the Landlord will just take that repair out of my rent’. My regular handyman is getting calls from tenents asking him to come prepare the unit for move out so they can save some money on the repairs since my contract charges a premium for repairs left undone at move out.

    If a tenent needs to move due to a life change, do you really think you will collect on the lost rent during the balance of a lease? If they could afford to stay they would since we have nice places. Therefore what good is a lease to the landlord?

    So far it has been very good, although my property manager is shocked at the move in inspections which list every chipped floor tile and tub scratch.

    Andy Teasley

    • Ali Boone

      Hi Andy, thanks for commenting! I definitely understand the side of having tenants who truly can’t pay double the deposit. Like I’ve said a few times, this tactic doesn’t work in all scenarios. But even still, if it is all lower income, the rents are much cheaper which would mean the money required wouldn’t be as high. Let’s say a whole low income house rents out for $500. First month and two months’ security would only be $1500. Much different than $3000, say. Either way, it’s still just one of many tactics.

      I’m not sure I see the benefit of what Bruce Norris suggests. How does he plan to collect money from tenants after they have left? I wouldn’t see that working often at all. Then my other issue would be, and this one is very debatable and has been debated in past blogs, I don’t want my tenants making repairs on my property. I wouldn’t trust the quality of the work and wouldn’t want to be left with bigger problems later when their potentially cheap fixes fail. But, that is totally personal preference.

      And yes, you make a good point. Leases are actually fairly worthless to property owners most of the time. They hold up in court, but it doesn’t guarantee collection. Leases have never fully prevented tenants from leaving, nor will they ever. They may definitely encourage tenants to stay, but they can’t force it.

      • Andy Teasley on

        Ali,

        In my experience bad tenents always leave me a broken mess and the good ones leave a nice place. I don’t think it depends on my unit, my property manager or a deposit. Bad tenents are just low class rotten sc*** , scratch that, people. 😉

        I can’t imagine it being worth the hassle to 1. try to find were they slunk off to. 2. serve them. 3. get a judgement 4. collect some money. So, as you can tell, I never bother trying to collect from a bad tenent, I just write if off as the cost of being a landlord. Unless of course they are really destructive then my insurance company may go after them, however I have never recieved a check from Farmers when they collected my deductable from the bad tenent, so I don’t think they’ve collected either.

        All that to say the contract is only used to train the prospective tenent, not to truely collect.

        RE tenent repairs, if the quality is lacking then I still have to pay the handy man to fix it. If the tenent replaces the toilet handle they broke themselves, it will probably work just fine. If their boyfriend put his fist through the wall and did a poor repair, my guy has to cut a square hole and properly repair it the same as if the hole was still there and unrepaired.

        By the way, Bruce was just the interviewer, this system comes from Shawn Watkins.

        Thanks for the prompt reply, I enjoy your posts.

        Andy Teasley

        • Ali Boone

          Thanks, Andy! I appreciate the compliment and thank you back for your comments! Great inputs here. You’re right about the repairs and good thought for me to consider.

          Haha… you’re totally right about leases! And collecting money.

  6. Hi Captain Obvious:

    1. Most states have a maximum you can charge for security deposit. Our state is 1-1/2 times the rent. No, we cannot charge double (bummer). And, our state does not allow us to charge last month’s rent.

    You are dead-on when you say that you end up paying whatever they don’t which leads me to my second point.

    2. If they don’t have the required move-in money, they can’t afford the rent. No, you should not let them make payments on their move-in money. If they don’t have the required move-in money, they can’t afford the rent. Am I making my second point? Feel free to ask me how I know…. (the answer should be captain obvious).

    • Ali Boone

      Lol! Karen, your comment is probably my favorite comment in a while! Hilarious. Ummm…dealt with any tenants who couldn’t afford the rent lately? 😉 But yes, I think there is merit to what you say that if they can’t afford the deposit and first month’s, they can’t afford it. I have a friend who was recently talking about if he had to find a place to rent that he wouldn’t have enough money for a security deposit. He lives very paycheck to paycheck, so I understand that throwing out say $1500 would be hard to impossible, and he does pay his current rent every month, but he does tend to be late with most payments because he’s waiting to have it in full, but more than that… if a teeny tiny anything happens in his life that costs money, he’ll immediately not have the full rent payment to give. So while it may work fine for a while, one hiccup and you lose a rent payment.

      Great put about the state laws! I didn’t even realize there can be caps. Very important for everyone to know!

  7. Robert Watkins on

    Hello Ali,

    Thank you for your posts!! I have recently become a landlord and these posts and replies are a great source of help for future alterations to the contract between the tenants and myself.

    Robert Watkins

    • Ali Boone

      Thanks, Robert, and I’m glad they are helping out! I’d say definitely make sure you just saw Karen’s comment about the state laws as that’s something I didn’t even know and is definitely a factor. Definitely hit up any BPers that have experience with property management, like Karen or others. I don’t personally manage any of mine so I don’t always know the tricks of the trade, but they definitely will and would be great resources for you.

      Happy landlording!

  8. Thanks for the post Ali, I know by experience being on the renter end of property in a somewhat transient area, many landlords of such property across all price categories charge a substantial security deposit in addition to first and last months rent prior to move-in. This helps them cover any losses from tenants who skip out unannounced before their lease expires. Thanks for calling this to our attention; especially helpful to me, since I am soon to become a landlord myself, and I am going to stick to my guns on this issue. All the best, Paul W.

    • You bet, Paul. Happy landlording as you get started! (where are you investing?) There are a lot of things I never understood being a renter, but now that I own properties, it’s allllll making sense now. Lol.

  9. Alot of what we discuss in investment real estate is local market driven…meaning, what you can do in LA (2 or 3 months deposit) and what you can do in an inner city rental (atlanta, kansas city, mephis) are completely different things. Some state, including GA, have fairly strict deposit laws and running afoul of those can get expensive…usually triple damage fees. So before you do anything with deposits….check your state laws.

    On most of our properties, we’ve switched from a deposit to all or 1/2 of last month’s rent. We have low income properties and high income properties….but most of what we do now is create shared housing. We buy and joint venture with other investors to take empty houses, furnish the common areas, include utilities and charge a monthly rent per room. It works for us…our returns are better, we have little vacancy and no vandalism.

    The articles are great. It’s always a good idea to compare notes with other investors and agents in your local markets to see what the norm is. Happy investing!

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