Something that we are seeing more and more of industry-wide is prepaid rent so Scot Aubrey looks at the perks and pitfalls of prepaid rent.
The Saturday mornings of my youth were spent eating pancakes and watching cartoons on TV. One in particular, Popeye, had a character named Wimpy who was a well-known cheapskate. The line that defined his character most was “I’d gladly pay you Tuesday for a hamburger today.”
Of course, he rarely showed up on Tuesday to pay his debt; as a landlord, you may be all too familiar with this type of scenario. On the other side of this is something that we are seeing more and more of industry-wide, and that is prepaid rent, where a prospective tenant might say “I’ll gladly pay you today for a roof over my head for the next 6 months.” For applicants that do not qualify for your property in a traditional way due to financial or other issues, prepaid rent may be an option that helps fill a vacancy and assists someone with housing.
As with anything outside the normal transaction, there are some rules to be aware of that vary from state to state so we always advise consulting your local landlord attorney on what works best for you. With evictions on the rise, please review the following guidelines to be aware of if presented with this unique way of collecting rent.
What Prepaid Rent is Not
Sometimes the best way to understand what something is, is to understand what it isn’t. In this case, prepaid rent is not:
- A substitute for criminal and credit background screening checks. Always adhere to your criteria in every situation and do not be tempted to change a “denied” applicant with disqualifying criminal or credit history into an “approved” as a response to their offer to prepay rent.
- A security deposit: Most states limit the security deposit to 1.5 times to 2 times the monthly rent. However, there is normally not a cap on prepaid rent amounts.
- A holding account for your tenant to use when they need funds: The tenant must understand that they forfeit rights to this money until it has all been used to cover the agreed-to payments for the agreed-to rental term.
- A source of funds for tenant late fees, court fees, or attorney fees.
As an example, if you collect $6,000 in prepaid rent and the rent is $1,000 per month, you have six months’ rent. Nothing more, nothing less.
Looking for Volunteers
Don’t go running out and start shouting from the rooftops that you are now accepting prepaid rent for your property. In every state this will immediately get you in trouble. The key word to understand when discussing prepaid rent is voluntary. I can’t stress this enough; the tenant must initiate any and all conversations regarding prepaid rent. Any mention of it by you as the landlord could be considered coercion, and that will get you an automatic loss in court.
Get It in Writing
If your tenant initiates a conversation about prepaid rent, make sure before collecting any monies that you have the agreement in writing. Ideally you would have this included and agreed to in your lease. If that’s not possible, we recommend creating an addendum that should be signed by both parties. You can receive a free copy of our recommended addendum language by requesting it from email@example.com.
As recommended earlier, it is a best practice to create a separate account for each property where you can hold any prepaid rent. Two important things if you accept prepaid rent are:
1) If, and only if a tenant is evicted from the property, you can use any remaining prepaid rent to pay for expenses related to the property that exceed the security deposit, and
2) No refunds of excess funds are considered returnable until the lease/contract has been completed and all accounting is completed. Let me reemphasize that the security deposit and any prepaid rent are completely separate and should be managed in a way that you can verify their independence.
Ideally, every one of your tenants would come to you financially qualified with a crime-free history and no record of evictions. In reality, we know that many of your applicants may present issues that disqualify them from being the ideal tenant. If they offer to prepay their rent, use this as a reference point and counsel with your landlord attorney to ensure you are following your local and state laws.
About the author:
Scot Aubrey is vice-president of Rent Perfect, a private investigator, and a fellow landlord who manages short-term rentals. Subscribe to the weekly Rent Perfect podcast (available on YouTube, Spotify, and Apple) to stay up to date on the latest industry news and for expert tips on how to manage your properties.
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