When a new tenant moves into your property, it’s time to start generating income from your investment.
And not just from the first month’s rent – you have two other instant revenue options as well: the last month’s rent and the security deposit.
Both of these are excellent ways to test a tenant’s financial stability and sincerity about renting your property for the long term. However, they’re not mutually exclusive. If you wanted, you could charge for both, one, or neither.
You need to understand the differences between charging last month’s rent and collecting a security deposit to make your decision on what you’ll ask for. Today, we’ll explore those differences.
How a Security Deposit and Last Month’s Rent Are Different
What is a Security Deposit?
A security deposit is a tenant’s property, and it should be held for a tenant for the duration of their tenancy.
It’s typically an amount equivalent to one month’s rent, and is intended to cover any damages beyond normal wear and tear to a property.
“Normal wear and tear” is pretty straightforward – if the carpeting shows signs of use, then that is considered “normal.” Carpeting covered in large stains, on the other hand, would not fall under the definition of “normal wear and tear.”
If, when a tenant moves out, a landlord finds that damage beyond normal wear and tear have occurred, the landlord doesn’t have to legally return the security deposit.
You should collect the security deposit before the tenant actually moves into the property. You should also be sure to include the amount of money and the date the security deposit was collected in your lease agreement.
Maryland landlord-tenant laws state that a landlord may charge a tenant up to the equivalent of two months’ rent for a security deposit. Montgomery County landlords must also provide a receipt that describes the tenant’s rights to inspections, the right to receive an itemized list of the deposit deductions, and the penalties for the landlord’s failure to comply.
On top of that, Montgomery County landlords must pay interest on any security deposit $50 or more at an annual rate of 3 percent. You can calculate your tenant’s security deposit with added interest on the Department of Housing and Community Development website.
Landlords are required to return their tenants’ security deposits within 45 days after they move out, as long as both parties met the agreements outlined within the lease. If a landlord fails to return any part of the security deposit within that period, they could face a lawsuit and may be liable for three times the withheld amount.
What is Last Month’s Rent?
If you require your tenants to pay a last month’s rent, you effectively give yourself a form of insurance against their leaving without giving you proper notice.
Think about it this way: if a tenant signs a one-year lease, they won’t have to make any payments during their twelfth month of tenancy.
Collecting last month’s rent is also a great way to attract higher quality renters. Such a barrier for entry allows only those potential tenants with the appropriate cash on hand to move in. Because it can be so difficult for someone of lesser means to move into a new home and pay such a substantial cost, you’ll have significantly fewer (but probably higher-quality) applicants overall.
Just remember, if a tenant has reason to legally breach their lease agreement before the twelfth month, then you would be obligated to return their last month’s rent. Instead of finding yourself simply needing a new tenant, you’d also be a full month’s rent in the hole.
For a more extensive look at last month’s rent, check out this recent blog post.
What’s the Big Difference?
The biggest difference, clearly, is that you don’t have to return the last month’s rent. That isn’t the tenant’s property – it’s yours.
The security deposit is not actually “income,” but keeps you free of any financial headaches after a tenant moves out. But if you can’t legally hold onto it, you have to return it within that 45-day period.
Because a last month’s rent is part of the overall money owed by the tenant, it doesn’t technically count towards anything other than your tenant’s cost of living in your property. This forces you to pay for any cleaning or repairs needed at the end of the lease.
Your best bet to keep yourself safe and flexible is to require tenants pay a security deposit, and to follow the Maryland state laws on handling the money. The deposit should be as high as you think necessary to cover whatever potential losses you could face.
“Living Out” a Security Deposit
Sometimes, your tenant may try to “live out” their security deposit. Instead of paying their last month’s rent, they ask you to apply the security deposit you’ve already collected from and owe them to their last month of rent.
This can be somewhat risky for landlords. For instance, if your tenant has caused any damage to the property, you probably won’t have enough security left over after you deduct their last month’s rent to pay for the damage they caused. If your security deposit was only the equivalent of one month’s rent, this is especially true.
The best advice in this case is to never allow your tenants to live out their security deposits. If you did not require a last month’s rent when they moved in, collect the last month’s rent as you normally would and return them their security deposit within the legal period minus any necessary deductions.
Increased Rent Amounts and Last Month’s Rent
One issue Montgomery County property managers might run into when they choose to collect last month’s rent is the issue of increasing the amount of rent due.
If you increase the rent due every month but fail to require your tenant to increase the amount of their pre-paid last month’s rent, you can’t collect the extra amount when the tenant moves out.
When the tenant moves out, there will be a difference in what they initially paid as last month’s rent, and what the actual last month’s rent costs. But you cannot make the tenant pay the difference.
This may not be the most upsetting outcome – especially if the amount you raised the rent was small enough that its absence doesn’t impact your finances.
The differences here are pretty clear: a deposit is always helpful, and a last month’s rent can be as well. And whether you want to ask for both, one, or neither is entirely your decision.
Take a step back from your business for a moment, and ask yourself:
What sort of tenants will my properties most likely attract? What sort of tenants do I want to attract?
The answers to these questions are different in every individual case. What’s important is that you understand these differences and decide what you should do to grow your rental property business.