How much security do security deposits actually provide?
Security deposits are only as effective as the policies landlords have for them. But most mom-and-pop landlords end up learning the hard way that security deposit mistakes are among the costliest they can make.
Sure, most landlords know that there are state-specific limits on what they can collect as a security deposit (see our state landlord-tenant law summaries). And that’s about the extent that most landlords think about their security deposits.
So what do landlords get wrong with their security deposit policies? Here are five common security deposit mistakes that landlords make… and some actionable tips for better results.
Mistake #1: Assuming the Security Deposit Will Protect You
Security deposits protect against exactly one thing: minor tenant damage to the property. They don’t protect against major damage (anything costing more than the deposit collected). They don’t protect against “normal wear and tear” (which often requires $4,000-6,000 in fresh paintjobs and new carpets). Nor do they protect against rent defaults (the eviction process can take as long as 5-9 months). And they certainly don’t protect against lawsuits.
So what can landlords do to protect against those costs and risks?
First and foremost, landlords should aggressively screen all rental applicants. We have entire articles devoted to tenant screening, but start with tenant credit reports, criminal background checks and nationwide eviction reports. Call each applicant’s employer to verify income and future employment prospects. Call current and prior landlords to verify rent payment history.
Beyond tenant screening, sign a thorough, protective lease agreement. It must be state-specific and comply with all state requirements (including required lease clauses and disclosures). But it should also include clauses that protect your property against damage. (See our article on little-known lease clauses to protect you as a landlord.)
Once the renters move in, conduct semiannual inspections of the leased unit. If you don’t like the way the renters are treating your property, you can send them a notice to improve their behavior, and you can non-renew the lease agreement with them when the end of the lease term approaches.
Mistake #2: Failing to Do Move-In & Move-Out Condition Inspections
If you don’t document the condition when the tenant moved in, and the subsequent condition when they move out, how can you prove what damage was caused by the tenant?
You can’t. When they object to you deducting money from the security deposit to cover their damage, the renter can simply say “That damage was there when I moved in.”
Use a Move-In/Move-Out Condition Report, and walk through the property in person, with the renter, both at move-in and move-out. Write out every damaged item, every scar, every scuff. Initial each line, and have the renter do the same. Photograph each item, with a timestamp. If for some urgent reason you or your leasing agent can’t walk through the property with the renter in person, include a provision in the lease that the tenant must sign and return a condition report within an allotted time. Go one step further and specify that if the tenant fails to return the report, the rental is received as satisfactory.
Save the Move-In/Move-Out Condition Report in your file, along with printed photographs. Also keep digital copies saved in your digital file for the property. (As a side note, you should always keep both hard copies and digital files – it’s too easy to lose either one, and we’re talking about assets worth hundreds of thousands of dollars here!)
If you ever need to defend your security deposit deductions to a judge, you’ll have ironclad proof of what damage was pre-existing and what was caused by the renter.
Mistake #3: Failing to Hold Deposits in a Separate, Interest-Bearing Account
Many states require landlords to hold each security deposit in its own separate, interest-bearing bank account. Even if your state doesn’t require this, do it anyway.
To begin with, it makes your accounting easier. But more importantly, it prevents any temptation for you to spend the security deposit. You’d be amazed how often landlords commingle their tenants’ security deposits with other funds, spend the money, then scramble to find money when the tenant moves out.
And hey, if the security deposit earns interest and you don’t have to give it back to the renter, it’s found money, right?
Mistake #4: Missing Security Deposit Deadlines
Every state has its own rules on how and when landlords must refund vacating tenants’ security deposits. Or, as the case may be, providing a written breakdown of deductions.
In most states however, if the landlord misses the deadline to provide a written breakdown of deductions, they lose all rights to deduct any costs from the security deposit. They must refund the deposit, in full, immediately, often with nasty fines and penalties.
Do no pass Go, do not collect $200.
Your rental investing business is a business. You need to operate as such, because you’re under strict deadlines. When you miss them, it will cost you dearly.
Mistake #5: Deducting Your Own Labor Expenses Without Documentation
Landlords get into a fuzzy gray area of the law when they do the repairs themselves after a renter moves out, and they deduct from the security deposit to pay themselves.
If you do this, make dang sure that you cross every T and dot every I. Keep detailed records of your hours worked, keep receipts for all materials. Charge an hourly rate comparable to other providers for this type of work.
If your ex-renters take you to court over the deductions, be prepared with four types of evidence: the damage itself, that it was caused by the renters, that the time it took you to repair it was typical of industry standards, and that your hourly rate was typical of industry standards. The burden of proof will lie squarely on your shoulders, to prove that your labor deductions are legitimate.
What Else Can Landlords Do with Security Deposits to Protect Themselves Better?
Here are a few more tips for success, to protect yourself, your property and your returns:
- If you allow pets, charge higher rent (“pet rent”) and a pet deposit for each pet. Pets cause extra wear and tear and extra damage to your rental property, period. There are good reasons to accept renters with pets, but you need to protect your property, too. Note that in most states, pet deposits are lumped in with other security deposit restrictions – if your state limits security deposits to 1.5 months’ rent, you can’t charge one month’s rent for the security deposit plus one month’s rent for the pet deposit.
- Thinking of accepting a higher-risk renter? Collect a higher security deposit. If you’re considering taking a risk on a rental applicant with a patchy credit or housing history, collect the maximum security deposit allowed by law in your state. You might also consider requiring a co-signer for the lease agreement, and/or requiring that the rent be deducted directly from the tenant’s paycheck. (Hint: SparkRental will be providing this service soon!)
- Know the difference between damage and “normal wear and tear.” As a general rule, damage is caused by a single incident, while “normal wear and tear” is caused by repeated use of a lived-in space. With that said, it should be your mission to minimize normal wear and tear too. How? Lucky for you, we have an entire article devoted to tenant-proofing your rental property!
What security deposit mistakes have you made? Have any gnarly stories to share, to help other landlords avoid the same mistakes? Don’t be embarrassed, I’ve made plenty of my own mistakes!