How to Handle Security Deposits and Refunds

Before a tenant gets the keys to their rental, you’ll want to ensure that you’ve collected a security deposit from them first.

A security deposit serves as financial protection for landlords against potential damage that might occur during the tenant’s stay. It can also serve as protection in case of unpaid rent. The deposit is usually held by the landlord in a separate account and is typically refundable to the tenant, minus any legitimate deductions, when the tenant moves out.

While the concept sounds straightforward enough, there are state laws in place that dictate how security deposits should be used. There are also laws that stipulate how long you have to return the deposit to tenants, how much you can collect, and more. To help, you’ll want to learn about how security deposits work.

In this article, we’ll look at how you should handle security deposits for your rental properties. Let’s dive in now.

Benefits of Charging a Security Deposit

You might be wondering, if security deposits are only going to cause headaches, shouldn’t you just forget about charging them? While it’s ultimately your choice whether or not to charge a deposit, you should be aware of the advantages that come with collecting them.

 A security deposit can:

• Offer Financial Protection: Security deposits provide landlords with a financial cushion in case of damages to the property beyond normal wear and tear. It also serves as compensation if the tenant fails to pay rent, helping to protect your income.

• Encourage Compliance With the Lease: Tenants may be more likely to take care of the property when they know that their deposit is at stake. It can also motivate tenants to adhere to lease terms, including giving proper notice before moving out, leaving the property in good condition, and paying rent on time.

• Streamline the Move-Out Process: When tenants know they need to leave the property in the same condition as when they moved in to receive their full deposit back, it helps streamline the move-out process and encourages them to clean and repair any damages.

Understanding Security Deposit Laws

To prevent problems concerning security deposits, it’s important to familiarize yourself with the regulations in your state to ensure compliance. Each state in the United States has specific laws and regulations regarding security deposits.

Common aspects regulated by local laws include:

• Maximum Deposit Amount

• Interest Requirements

• Itemized Statements

• Timelines for Refunds

• Security Deposit Usage

Some states place a limit on the maximum amount landlords can charge as a security deposit, and these limits can vary greatly. Some states, such as Alabama, Washington, and Hawaii currently only allow amounts of up to one month’s rent. Maine, Arkansas, and Iowa currently allow up to two months. There are states that currently have no limits, such as Florida, Georgia, and Minnesota. Always check your state’s laws for the most up-to-date regulations.

Certain states mandate landlords to keep security deposits in a separate account, and in some cases, in an interest-bearing account. The rules often include notifying tenants of the account location and other related details. Connecticut, Chicago, and Massachusetts are some of the locations that have this requirement. Most of the time, tenants are entitled to any interest earned.

There are deadlines when it comes to returning the security deposit after the tenant moves out. Failure to comply may result in penalties, so make sure to be aware of these time periods. Most security deposit return timelines range from 14 to 30 days, with a few states allowing up to 45 or 60 days. 

However, if you discover property damage caused by your tenant during your move-out inspection, you might be entitled to use the security deposit for repairs. Providing an itemized list of deductions, along with receipts or estimates, is often required by law. This transparency ensures that tenants understand the basis for deductions.

State laws typically specify how security deposits can be used. This typically includes deductions for unpaid rent and damages that go beyond normal wear and tear.

The Authorized Use of Security Deposits

Next up, let’s look at the allowed uses of security deposits.

1. Property Damage Beyond Wear and Tear

Security deposits are commonly used to cover the costs of repairing any damages to the rental property caused by the tenant’s actions or negligence. These damages should go beyond normal wear and tear.

You may typically use the security deposit for things such as:

• Broken appliances due to misuse

• Missing appliances

• Clogged drains from misuse

• Broken tiles, toilet, or bathroom fixtures

• Tears, holes, and burn marks on upholstery, carpets, and curtains

• Broken windows, screens, doors, and locks

• Holes in walls

“Wear and tear” refers to the natural deterioration that occurs with regular use. To fairly assess damages and avoid misunderstandings, landlords should conduct thorough move-in and move-out inspections. 

You may not typically use the security deposit for things such as:

• Furniture marks on the carpet

• Scuffs and patches on hardwood floors

• Fading paint or wallpaper due to sun exposure

• Wall dents from door handles

• Faded curtains

Security deposits may be able to be used to replace fixtures that have been damaged or removed. Or to remedy other damage caused by the tenant to the property or items provided by the landlord, such as furniture, appliances, or fixtures. However, landlords should avoid using the security deposit to make upgrades or improvements. Likewise, the security deposit generally should not be used for cleaning carpets, applying a fresh coat of paint, or any other jobs that are required to give the property an overall refresh as faded paint or worn carpet would typically fall under the category of normal wear and tear.

To avoid disputes, landlords should document the condition of their property at the time of move-ins and provide supporting documentation for repair or replacement costs. 

You can also consult an attorney if you are uncertain about what repairs or maintenance tasks you can use a security deposit for.

New to property investing? Read 12 Common Mistakes Made by New Real Estate Investors.

2. Cleaning Fees

While tenants are expected to leave the property reasonably clean, some might not meet this expectation. Landlords can deduct cleaning fees from the security deposit to cover the costs of restoring the property’s cleanliness to an acceptable level. However, deductions for cleaning should be based on actual expenses and not used as a way to generate additional income.

A landlord may only charge cleaning fees if the rental unit is excessively dirty, infested with pests, developed excessive mold or mildew problems, or has pet messes like urine stains and lasting odors.

3. Utilities and Bills

If the lease agreement specifies that tenants are responsible for certain utility bills or other expenses, landlords can use the security deposit to cover unpaid amounts. This might include electricity, water, gas, or any other agreed-upon utilities. Be sure to document any outstanding bills and provide evidence of the amounts owed.

4. Re-Keying or Lock Replacement

If tenants fail to return all keys or change locks without permission, landlords can deduct the cost of rekeying or replacing locks. This ensures the security of the property for future tenants and prevents unauthorized access.

5. Landlord’s Costs

In some cases, state laws allow landlords to deduct certain costs that result from tenant-caused issues. This might cover legal fees associated with eviction proceedings or court costs stemming from a breach of the lease. However, these deductions should be clearly specified in the lease agreement or allowed by local regulations.

Tips for Handling Security Deposits

Here’s a look at some things you’ll want to keep in mind when handling security deposits:

1. Implement Move-In and Move-Out Inspections

A comprehensive move-in inspection is the foundation for handling security deposits effectively. Document the condition of the property thoroughly, and take photographs of any pre-existing damage or wear and tear. Involve the tenant in this process to ensure mutual agreement on the property’s condition.

When a tenant moves out, conduct a thorough move-out inspection. Compare the property’s condition to the initial move-in inspection report. This comparison will help to determine if any damages occurred during the tenant’s occupancy and whether deductions from the security deposit are warranted.

Read Perfecting a Seamless Move-Out Process.

2. Ensure Proper Communication and Documentation

Open and transparent communication helps make the security deposit process smoother. Inform tenants about your expectations for property care, the move-in and move-out inspection process, and how deductions will be determined.

Additionally, keep good records throughout the tenancy. Document any communications, agreements, and maintenance requests in writing. This documentation can serve as evidence in case of disputes over security deposit deductions.

You should also consider using digital tools to streamline the security deposit process. Online platforms can assist in creating digital move-in and move-out inspection reports, sending automated reminders for lease end dates, and providing a secure platform for tracking deposits and refunds. These tools can improve efficiency while reducing the likelihood of errors.

Check out Different Communication Options for Landlords and Tenants.

3. Know How to Handle Disputes

Disputes over security deposit deductions can arise, even with the best practices in place. If a tenant disputes deductions, be prepared to provide evidence to support your claims. If the dispute remains unresolved, some states have designated agencies or small claims courts where tenants and landlords can seek resolution.

How Much Should You Charge for a Security Deposit?

Calculating the security deposit starts by taking a look at the laws in the state that your property is in and determining the maximum allowable amount that you’re able to charge. Some cities may have laws in place as well, outlining how much you can charge. If you live in a city or state with no security deposit limitations, factors to consider when setting an amount include the rental price, property type, and local market conditions. 

Here’s a quick guide on how to calculate a security deposit:

1. Check State Laws First

Begin by researching your state’s landlord-tenant laws and regulations. If your state has a maximum limit for security deposits, make sure you are aware of that limit. This limit might vary based on factors like the duration of the lease, the property type (residential or commercial), and local laws. Ensure that you do not exceed this limit when calculating the security deposit.

2. Evaluate the Rent Amount

In many cases, landlords calculate the security deposit as a multiple of the monthly rent. Common multiples range from one to three times the monthly rent. The exact multiple might be influenced by factors such as the property’s condition, local market conditions, and your level of risk tolerance.

3. Consider Property Type and Condition

For higher-end properties or those with valuable furnishings and appliances, you might consider setting a higher security deposit. Properties in need of maintenance or repairs might warrant a higher deposit to protect against potential damages.

4. Market Conditions

Local rental market conditions can influence the security deposit amount. In a competitive market with high demand for rental properties, you might be able to charge a slightly higher security deposit. Conversely, in a softer rental market, a lower deposit might make your property more appealing to potential tenants.

A security deposit is like a double-edged sword. If you know what you’re doing, it’s a great way to help protect yourself from financial loss. But if you don’t, you could end up in violation of landlord-tenant laws. Your best option is to ensure that you carefully review your state laws concerning security deposits, check to see if there are any local regulations in place, and then build your security deposit process around those laws.

And of course, if you’d like to spend less time on security deposits, and more time on other things, then you could always enlist the help of a property manager. A professional property manager should have extensive experience managing properties in your local area, and should have a good working knowledge of landlord–tenant law. They can help with security deposit collection, inspections, and more, operating in your stead. This can free you up, giving you more time to spend on growing your investment portfolio. 

Are you ready to work with a property management company? Learn more about Renters Warehouse 24/7 hassle-free property management services. Get started right away with the Renters Warehouse Free Rental Price Analysis.