Ask Lucas 028: What is a “Holding Deposit” and How does it Work?
Jenny is wondering what is the best practice for a “holding deposit” or “good faith deposit”, and can it be non-refundable? How does it work?
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Lucas: Hello, and welcome to the 28th episode of Ask Lucas! Today, we’re answering a question from Jenny who’s asking, “What is the best practice for a holding deposit and why should I care?” It’s a great question because we get that all the time on Landlordology and I can’t believe I haven’t answered it on this show yet.
To give you a little background. I am Lucas Hall and this is a bite-sized Q&A show where I answer your questions about landlording and property management. It’s something I’ve been doing for 10 years and I have been able to develop a profitable rental portfolio for myself and my family, and I want to teach you how to do it. If you have a question just leave a recorded message on asklucas.com and I will try to answer it here.
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Jenny: Hi, Lucas. Thanks so much for your podcast. My question today is in regards to the best practices for a hold agreement. For my first go around here as a landlord I had a party that wanted a property but could not occupy it for another 20 days or so. I had a little bit of fear that they might back out while I was holding it for them. What I did was send them a form for a non-refundable hold deposit. I made that amount the same as the security deposit. The verbiage on the document says that once they sign the lease then that money then converts to their security deposit. This way I don’t make any extra money on this agreement but I have some kind of assurance that they’ll actually sign the lease and move in on the agreed-upon date. Anyway, I would love to hear your opinion and your advice on what to do in the future, or if this was a good idea. Thanks so much, Lucas. Bye-bye.
Lucas: Hey Jenny, thanks for your great question. We actually get that a lot on Landlordology. I think there’s some confusion about what a holding deposit is, so thank you, thank you, thank you. Before I get into the details I’ll just tell you that what you did is exactly what I do. It solves a real problem. That problem is, when a tenant comes to view a place and they want you to reserve it for them you really have no assurance. That holding deposit is their way to put their money where their mouth is. That money is nonrefundable typically. What it means is that you’re going to take the unit off the market and they’re going to put money towards it. If they back out for reasons of their own, if they just choose to walk away for whatever reason then that money goes to compensate you as a landlord for the time that you lost while you were wasting it on them. You might have lost two, or three, or ten, or dozens of other potential applicants and the place may stay on the market for another month or so.
That’s what the holding deposit is supposed to compensate you for. A lot of people don’t realize that that holding deposit is nonrefundable, so it’s so critical that you actually make it very straight forward and you let them know that this is nonrefundable and this is your promise that you are going to sign a lease. If they sign a lease then they get that money back really in the form of a security deposit. You can convert that holding deposit to a security deposit. They are two different things. One is to hold the place before you sign a lease. The other is for damages to the place or lost rent or anything like that afterwards. They don’t actually have to pay another security deposit, it just gets transferred and then they get it back at the end of the lease.
If I collect their application and I tell them, “Hey, if you want to get this place you need to put down a deposit, or a holding deposit, and I explain what that is. Then, we walk through that application process and they don’t qualify, because this happens a lot, too, they don’t qualify. Maybe their credit report is bad or maybe they don’t make enough. It’s less than what they said, or something. If I reject them because they don’t meet my standards then I give back that money 100%. It just is the way it is. It can’t keep it just because I didn’t like their credit report. They are still willing to rent it, I’m the one that changed my mind. If that happens I give them back 100% of the holding deposit and I move on to the next Applicant and such is life.
That’s just the way it works. I move on and I may have lost a little bit of time. That’s exactly why it’s so critical to get through that screening process within like 24 hours. As best as you can just quickly try to screen them so you know if you’re going to proceed with a lease or not.
That’s holding deposit in a nutshell. In some states it’s called an Earnest Money Deposit and that actually stems from the original idea of when you’re buying a house you give an earnest money deposit to show your financial muscle, and that just says, “Hey listen, if I back out,” that’s not a contingency like a financing contingency or home inspection contingency or something, “If I back out just because I change my mind you get to keep this money.” It’s the same thing with rentals. That’s where it comes from. That’s the problem it solves. That’s what I do.
I noticed what you did say is that you had them sign an agreement for the holding money deposit. I think that’s a good idea. A lot of people just write it into the check. If they hand you a check just right there on the spot in the little memo section say holding deposit, nonrefundable. Put that in there and then that will act as a note for that. Anyway, hope that helps. Thanks for asking the question. It’s a really good topic. I appreciate it. Bye.