Ask Lucas 021: Why Don’t You Collect Last Month’s Rent?
Summary: Ryan asks about last month’s rent, and why Lucas doesn’t ever collect it. Is there a better way to provide security against a tenant who abandons the last month’s payment? Full Transcript: Lucas: Hey, what’s up, everyone? Welcome to the 21st episode of Ask Lucas. Today we’re talking about the pros and cons of collecting last month’s rent. I’m Lucas Hall from Landlordology and Cozy, and this is a bite size Q&A show where I answer your questions about landlording and property management. If you have a question, just leave a recorded message on asklucas.com and I’ll answer it in this podcast. Today’s question is from Ryan, but first let me tell you a little bit about Cozy. If you’re like me, you’ve struggled to find software that works well for your rental business. If you manage your own properties, there’s no better system than Cozy. I think it’s truly the best way for landlords to manage their own properties from application to move-out. With Cozy, you can collect rent online, accept online rental applications, screen your tenants, and order easy to understand credit reports. It’s simple, and the best part is it’s completely free. No other company on the planet let’s you process online rent collection and screen your tenants for free. Check it out. Get Cozy at Cozy.co. Now welcome Ryan. Ryan: Lucas, in one of your recent posts you listed that you do not require tenants to pay the last month’s rent, or you don’t recommend it. Just wondering why that is? Lucas: Hi, Ryan. Yes, you are absolutely right. I do not collect last month’s rent from my tenants and I don’t really think it’s a good idea for other landlords generally speaking. Let’s get into some of the ideas on why last month’s rent really isn’t a good idea, though it is a very common practice. First, it generally complicates things. It overly complicates things in my opinion. Tenants have a hard time understanding it. I think that they generally get the idea it’s like if I pay rent now I don’t have to pay it later. It’s something that they easily forget. Based on my experiences, I think that over 50% of tenants who have paid last months rent in the beginning typically forget about the fact that they did so, and then come last month, they just pay their rent like normal because they either set it up on autopilot or they just forgot. Then worse, I think probably about a quarter of landlords who collect last month’s rent probably forget, too. Suddenly they’re collecting that last month rent from the tenant and then they had forgotten that they even deposited something maybe a year or two or three years ago. It can get lost very easily. Two, it’s restrictive. In many states, including Massachusetts as an example, a landlord has to use last month’s rent for, surprise surprise, last month’s rent. You can’t use it for anything else. Let’s go through some scenarios. Let’s say you have a tenant and a landlord, and the tenant forgets that they paid last month’s rent and then pays the rent like normal. Let’s say it’s $1,000. Let’s say the landlord had originally first month’s rent, last month’s rent, and security deposit, so they had all that. Then now it’s time for the tenant to move out and they’re fully caught up on rent. They don’t owe anything. They even double paid last month because they forget, but they did about $2,000 in excessive damages to the property. Because the landlord collected last month’s rent, he can’t use it for any sort of damages. The landlord would be stuck having to refund that last month’s rent and then using the full deposit to cover a portion of the damages, and then turning around and having to sue the tenant in small claims court for the other $1,000 which he just refunded. Because he collected it as last month’s rent, he couldn’t use it for any sort of damages. I think that’s just crazy. Some states actually have laws about that. Then further, there’s a ton of states that have laws about commingling deposit money. If you collect a security deposit, you can’t put any other money in that account with it. You could take that last month’s rent and put it into your operating account for your business because it technically is rent money, but what happens and what I see happen almost on a monthly basis with landlords that I talk to is that they forget. I shouldn’t say that they forget that they collected it, but they forget that it’s in there. They have to replace the roof or the AC and they just move along and they spend the money. When last month’s rent finally comes about, they don’t have it in their account and their confused. They have a record of collecting it but it’s not there. Related: How to Handle Security Deposits Properly It makes for difficult accounting practice. One thing I do say is that if you are going to collect last month’s rent, make sure you set up an extra bank account for just that money so you don’t spend it, or have a really good accounting system or a really good savings account to cover you in that type of situation. Another thing to consider is what do you do when you have a rent increase. A lot of landlords don’t think about that or they only deal with short-term rentals, or maybe even a year or less, so there’s not much of a rent increase. Ideally as landlords we want to have long-term tenants. We want tenants who are going to stay for over one year, maybe two, three, four, five years, and make it easy on ourself so we don’t have to completely turn these places over every year. Then ideally, you want to raise the rent when you need to to cover any other increases. If the tenant pays last month’s rent in the very, very beginning of their lease and then over the course of, let’s say, three years, their rent goes up an extra $100, oftentimes the tenant just thinks this last month locked me into that rate. That’s not true. That just means that at the time it was $1,000, let’s say, but now their rent’s 1,100. You have to top off your rent. You have to go back to your tenant and say, “Hey listen, you paid last month’s rent but you have to pay an extra $100 to make sure it equals your current month’s rate.” Tenants, they don’t like that. They don’t like paying an extra $100 in the middle of a month when they weren’t planning on it. It doesn’t give them a warm and fuzzy, and then they associate that feeling with you as a landlord, because there really is a better way and they just don’t get why they have to deal with this. They may understand the concept but it just doesn’t leave warm fuzzies with them. Now let’s talk about what we can do in lieu of collecting last month’s rent. There might be a better option. What I do and what I recommend other people do is that they actually collect more of a security deposit. The good news is that in most states you’re allowed to collect two or three or maybe infinite amount of security deposit, really whatever you could get away with and whatever your market will allow for. There are certain states that do have restrictions on it. In fact, most states do have somewhat of a statute on it. Hawaii says that you can only collect one month’s worth of rent. Michigan, it’s only one and a half. Generally speaking, I find that consistently across the board it’s about two months rent, maybe three months rent, if there’s a statute at all. There are a few that restrict it less than two, but definitely go check out our state law pages on Landlordology to determine what your state says about this. Now you can check that out at landlordology.com/state-laws. Now if you can just collect two months worth of deposit, then you don’t have to worry about last month’s rent. You can use that deposit money to cover any unpaid rent or any fees or any damages that they incur. You don’t have to be restricted and bound by the fact that last month’s rent can be used only for last month. You can use a deposit to cover that last month’s rent if they skip out on it, or you could use it for $2,000 in hardwood floor damage that they caused when their dog chewed it up. It opens up the floor to being more flexible and gives the landlord the ability to compensate him or herself for the damages, just plain and simple. The only thing you really do by collecting last month’s rent is you bind yourself. You restrict what you can do, and it doesn’t really get you anything. Because if you wanted to collect essentially two months worth of rent in a security deposit and last month’s rent, you can just do that through a security deposit. To the tenant, it doesn’t matter. They’re still paying the same dollar amount either way. They don’t care. Further, with a security deposit you can actually tell the tenant, “Hey, this is fully refundable minus any excessive damages. If you just had normal wear and tear, you get this whole thing back.” They love that. All of the tenants, when they start out they think I’m going to return this place, they have good intentions, I’m going to return it in the way it was delivered to me and I’m going to even take really good care of it. When that’s true, then great; give back the whole deposit. If not, if something happens and they lose their job or they need to take off and they just skip out on the lease, then you can use that deposit money for actual damages, whether it’s financial or material. I hope that helps. That’s why I don’t collect last month