No landlord would be safe without a security deposit. Taking funds up front from a new renter is a must. There are of course many reasons why taking a deposit is important and in this article we will discuss some of them.
We will also look into how you should handle the deposit, when you should take the money and what you should do if anything goes wrong. Be mindful that the security deposit is a line of defence for you and can be a safeguard for your property. Never enter into a contract without one.
Why is Security Deposit Important?
Security deposit is your last line of defence against a bad tenant. It can cover you for loss of rent and also any damages that the tenants have caused to your property. This makes getting the right amount of security deposit important and it also makes it vital for you to get the funds before the tenants move into the property.
You will need to discuss the amount of security deposit due at the time of agreeing the lease. Most cities will have a minimum and maximum amount due, so it shouldn’t be too hard to agree what the deposit will be.
The amount tends to vary between four weeks and eight weeks rent. There will be instances where you can also take a larger deposit to compensate for lack of references or perhaps a poor rental history. Take advice from your broker if you are using one and try to ensure that the amount is sensible and is enough to cover unforeseen issues that may arise during the tenancy.
It should also be noted that in a number of areas you can claim amounts above the security deposit should it not cover the missing rent or there are extensive damages, however this would normally be something that would need to be handled in court.
In short, never agree to a lease where you do not take a deposit. In my opinion this can be a very bad idea. I admit that we should never go into the lease agreement thinking negatively about our tenants but we have to ensure that we are covered against problems. Would a business operate without insurance?
Handling the Security Deposit and Move in Funds
Agree on the rent and security deposit upfront and ensure that the first months rent, plus the deposit and any other fees are taken before you hand over the keys to the tenants. Have your broker negotiate the rent, etc. on your behalf and ensure that all due fees are noted in the contract.
No matter what happens never agree to handover the keys before the funds have cleared. This can seem stressful sometimes, particularly when tenants make their payments at the last minute. But remember if you are upfront and honest about the amounts due it is only the tenants fault if they are not paid on time. Having a broker on hand to deal with potentially stressful situations can be a real help and is certainly something I would advise.
When agreeing the deposit ensure that you are up to date with the rules and regulations in your area. This will avoid any problems in the future. As stated earlier some areas will have standard amounts that can be taken as a deposit. Rules will also make it clear what can and can’t be deducted from the deposit and the timeframe for doing this.
Some cities and states will have rules about where the deposits are held to ensure that the tenants money is protected during the lease. Obey the laws in your area and if you must register the deposit or hold it in a separate protected account make sure you do this. Many landlords have fallen foul of this regulation thinking that they will not be caught out.
If you don’t follow the rules you may find that you are fined for improperly holding the funds and you may also struggle to claim against the amount you were holding. This could be a potentially catastrophic double-whammy for you and one that should certainly be avoid.
Prior to Signing the Lease
As we have already touched upon it is important to have all of the funds, etc. agreed before you sign the lease. This means that the amounts due and what they are for can be included in the lease meaning that all parties understand what the funds are for.
The lease should also make provisions for how you as the landlord should hold the funds and what can and can’t be deducted from the deposit. Your broker should be able to draw up a good contract for you and should be working on your behalf to ensure that all of the above are covered.
Once the lease is signed and everything is down in writing I would advise you to take the funds from the tenant and then allow them to move in. Without labouring the point too much, do not give anyone access to your property without first paying the funds that are required by the contract.
Online payments are easier to track, often faster and are just a safer way to do business than the alternatives. Large amounts of cash can be annoying and potentially dangerous to carry to the bank and of course cheques are not guaranteed.
Today with billions of online payments are being made worldwide. This means it could almost be viewed as suspicious if someone is keen to avoid paying you via bank transfer. Transfers can be made safely and do not require you to give out your bank details as you can have your broker act as the middleman between you and the tenants. Once the funds have cleared into your broker’s account you should be able to take that as a given that the tenants are ok to move in.
Going forward I would advise organising all rent payments, etc. to be done online. It’s quite simple and avoids potentially awkward meetings or “money drops” with your tenants.
It can also be difficult to keep track of payments not carried out online which can make it harder for you to complete your tax returns. Online payments also have the benefit of being scheduled and you can organise reminders to yourself so you can always check that your rent has been paid on time.
When collecting the upfront “move in monies” ensure that you are taking the rent separately from the deposit. This is helpful in a number of ways. It keeps you informed of the amounts due; you will be able to tell what has been paid and what is outstanding. It also makes separating the funds easier for you. Most states make you hold the deposit in a separate account, so having the deposit come in a separate payment makes it easy to transfer straight to your nominated account.
It also pays to have a number of accounts that you can use for each property. My advice would be to have one rental account for each property that you own with only that properties funds being transferred into that account.
This is good practice as it means that you will not get confused as to what is outstanding on each property and can keep track of what is due and when. It can also be a benefit when holding the deposit if you hold numerous properties deposits together meaning that you can earn more interest on the amounts held (if your state allows this, some do not).
Claiming Against the Deposit
When dealing with rental properties you of course never really want to have to use the deposit. This clearly means something has gone wrong, be it an issue with rent or perhaps damage that the tenants have caused.
However from time to time in your journey as a property investor and landlord you will have to claim against the damage deposit. It is important in this case that you understand how to go about the process of claiming from the deposit.
You need to ensure that you understand how the process works and also the timeframes involved. Your broker is key to this process and with any property manager you have should be able to help you through the process.
The first point would be to ensure that you always have a thorough inventory carried out on the property; both at the beginning of the lease and at the end. This makes it very easy for you to show the condition of the property when you handed over the keys and the condition that the property has been returned in.
This of course, is particularly important when claiming damage costs from your tenants. You may find it tricky to claim anything from an outgoing tenant if you don’t have a solid, reliable inventory to fall back on.
In terms of claiming rent, this is where a good contract and also online payments make the process much easier. A contract clearly stating the amounts due, when and where is important as it can be used as evidence of missed payments.
Your online bank statements can also clearly show when rent has been paid and what has been missed. This is something you may find it difficult to prove if you are simply paying the tenant’s rent into your account as cash payments.
Use your broker and property managers to give you advice and walk you through the process. In the majority of instances this will not be the first claim they have dealt with and they may be better equipped to handle the situation than you are.
It pays at this stage to also be mindful that it is rare that the deposit is simply handed over to you. The more likely scenario is that you will have to fix any issues (where there is no rent due) and then claim the damages back via the deposit.
This is something I have often seen landlords struggle with as it does seem common sense that the funds would just be transferred to you, but in the vast majority of states this is not the case. It is important therefore, to keep receipts and invoices so that you can prove the amounts you are claiming.
We all like to think of tenants as being perfect and in the vast majority of cases they are. But just occasionally things can go wrong. When it comes to rent it could be something as simple as a family member losing their job. It could alternatively be something more sinister like willfully not paying rent.
This could also be the case with damages, accidents can and do happen and it pays to have accidents as well more wilful neglect covered in the form of a security deposit.
Follow the above and ensure that you are upfront with your incoming tenants and you will rarely suffer with issues surrounding the deposit. As discussed, get the funds cleared in advance and ensure that the contract you are using breaks down what is expected from you and from the tenants when it comes to the paying and returning of the deposit.
If in doubt use a good, reliable broker and property manager who will be able to assist you with the process of setting up the lease and will be able to help should any problems occur.