In a perfect world, landlords wouldn’t have to predict in advance what it may cost to restore a unit that a tenant damages. For instance, tenants simply could take out insurance that would pay the full amount owed to a landlord at the end of a lease term.
But for now, collecting a security deposit when a tenant moves in is the best a landlord can do to offset potential income loss. Those funds are readily accessible to cover repairs and help the landlord restore a unit quickly.
What to charge, however, is not always intuitive. It is impossible to foresee whether the losses will be minor or massive. In some cases a $200 deposit will be sufficient; in others, a $2,000 deposit would not be enough.
Just as rent is determined largely by market forces, when setting a security deposit, a landlord must also take into account a typical tenant’s overall cash outlay, especially if the landlord is requesting first and last month’s rent in advance. If a landlord is forced to choose, it may be worth considering keeping the deposit high, and forgoing last month’s rent.
The characteristics of the property itself also determine how much a landlord should collect as a security deposit. For instance, a single-family property may have added amenities like a hot tub or expensive landscaping which would warrant a higher deposit than, say, a standard studio apartment in a multifamily building.
Local law may have the last word when it comes to setting security deposits. A majority of states have passed statutes that regulate security deposit collection or deductions. The states which limit the amount a landlord can collect typically tie that cap to the amount charged for rent. Unfortunately, that one-size-fits-all approach seldom takes into account the actual condition of the property or any special characteristics that would justify a higher figure. Also, the maximum allowable deposit tends to be low in comparison to what landlords would like to charge. For those reasons, in states where landlords are limited, the best practice is to charge the highest amount allowed by law.
In states which do not regulate the amount landlord can charge for security deposit, the landlord should charge the highest amount they can without limiting the pool of qualified rental applicants. Advertising a low deposit or no deposit will attract the worst of the available tenants. On the other side of the spectrum, good tenants will have done their research, and will know how much a typical deposit should run. Coming in far over the norm will discourage the best of the candidates. Landlords who need to offer tenant incentives should come up with a different bargaining chip other than the deposit.
Another important idea to keep in mind is that the security deposit must be high enough to do its job — which is to serve as an incentive for tenants to keep the property in good condition. If the figure is too low to seem significant, or it appears that there is little chance that the deposit will be returned at the end of the tenancy, then the security deposit won’t adequately protect the landlord.
If we were to look at an average figure of what other landlords charge for security deposits, we would likely see an amount equal to one month’s rent. But, if you choose to match the monthly rent figure and the security deposit, it’s particularly important to make it clear that the funds are a security deposit and not last month’s rent. That security deposit figure should be stated clearly in the lease, and the tenant must understand that the deposit is not to be applied as rent.
Do not agree to apply the deposit to rent at the end of the lease. That’s the same thing as returning the deposit early. The security deposit is there to protect the landlord. The landlord has an opportunity to carefully inspect the property once the tenant has moved out in order to determine if there is any damage. By applying the deposit funds as last month’s rent, the landlord loses the opportunity to inspect the property once its empty and the tenant is no longer in a position to be concealing any damage.
In states where the security deposit amount is capped based on a rent figure, lease renewals are a little trickier. If the rent is increased at renewal, a landlord must decide whether to increase the amount of the deposit as well. That decision will largely be based on how well the tenant is doing taking care of the property. In order to determine this, the landlord must conduct a property inspection prior to agreeing to renewal.
If the amount of the deposit increase is insignificant, a landlord must consider whether asking for those additional funds will be more of an annoyance to the tenant than it’s worth. On the other hand, just because the tenant is there long-term does not mean they will remain a good tenant. The best path may be to anticipate this problem in advance, and include the provision in the lease so the tenant will know what happens in the event they choose to renew.
Pet deposits can work against a landlord is some cases. The best practice is to avoid designating a portion of the general security deposit as a pet deposit — because then those earmarked funds can only be applied to damage caused by pets. The exception is in cases where local law caps the security deposit, but allows additional funds to be collected as a separate pet deposit. Then, it’s in the landlord’s best interest to collect both.
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Disclaimer: The information provided in this post in not intended to be construed as legal advice, nor should it be considered a substitute for obtaining individual legal counsel or consulting your local, state, federal or provincial tenancy laws.