If there’s one part of security deposit management that consistently confuses landlords and property managers, it’s interest on a security deposit.
Depending on the State, interest on security deposits are vital to the accounting process for property managers. Example: Some states require landlords to place deposits in an interest bearing account and return accrued interest to tenants each year.
Others allow landlords to retain interest or credit it against unpaid rent at the end of a tenancy. The rules vary widely, and mistakes can cost property managers dearly in deposit laws, lawsuits, or tenant distrust.
At the beginning of a tenancy, security deposits are typically collected, making it crucial for landlords to understand regional differences in deposit laws to ensure compliance from the start.
Many property owners try to manage interest themselves by opening a simple checking account or pooling tenant deposits with other funds. Some keep the deposit amount in their own accounts and pocket the interest, an approach that’s both risky and, in many states, illegal. Others are unaware they’re supposed to pay interest to tenants at all.
This guide explains what deposit interest is, how it works, where property managers must comply with specific requirements, and why the best solution is automation.
What Does “Interest on a Security Deposit” Mean?
At its most basic, “interest” is the return a financial institution pays on money held in an account. When a tenant pays one month’s rent as a security deposit, the landlord or property management company may be required to place those funds in an interest bearing or escrow account. Over time, the deposit accrues value.
In many jurisdictions, the rules dictate that the security deposit landlord can collect is limited to one month’s rent or the equivalent of the monthly rent, and these terms are typically outlined in the rental agreement.
Key points:
- Tenant interest: In many states, the tenant is entitled to the interest generated, not the landlord.
- Accrued interest must be tracked separately from deposit amount.
- Some states require interest payments be made annually (e.g., at the end of the immediately preceding calendar year).
- In others, interest is only paid when the tenant moves or the lease ends.
Example: If a tenant places $2,000 into an interest bearing account and the interest rate is 2%, the landlord must calculate and either credit or disburse that payment according to applicable law.
State Laws on Security Deposit Interest
Deposit laws differ dramatically. Here are the common approaches:
- Mandatory interest states: In New York, Illinois, and Connecticut, landlord must place deposits in an interest bearing account and return the accrued interest (sometimes minus a small administrative fee).
- Conditional states: Some states require interest only if deposits are held longer than a year, exceed one month’s rent, or are placed in a pooled escrow account. In some areas, local governments may set a limit on the amount landlords can charge for a security deposit.
- No-interest states: Others have no laws mandating interest payments, though landlords still must handle deposits responsibly.
Many states also require landlords to provide tenants with a receipt as formal acknowledgment of the security deposit.
Failure to comply exposes landlords to penalties. If a landlord fails to pay interest when required, the tenant can file a claim in small claims court, sometimes recovering multiple times the deposit amount. Property managers need to know the security deposit rules in their state to avoid missteps.
Common Problems Property Managers Face
Pocketing tenant interest
Some managers assume they can keep the small balance of interest earned. In most states, that’s considered bad faith and can lead to litigation, or at the very least, poor reviews. Many times, some landlords see it as a perk, but this practice is frowned upon even in states that allow it.
Improper accounts
Mixing deposits with other funds or leaving them in an operating account instead of a dedicated escrow account is a common compliance failure. Most states now require property managers to set up escrow accounts specifically for security deposit funds.
Incorrect calculations
Interest rates change. A deposit held for less than a year may require prorated interest payments. Getting this wrong can result in disputes, especially over the exact amount of interest owed to the tenant. Disagreements often arise when the tenant moved out before the annual interest payment date, leading to confusion about what is owed.
Lack of communication
Many states require landlords to send a written notice to tenants each year showing where their deposits are held and how much accrued interest was earned.
Ownership transfers
When a building changes hands and a new owner takes over, deposits and accrued interest must be transferred properly. A former landlord who fails to hand over funds risks liability.
If you have questions or disputes about security deposit interest, especially after the tenant moved out, contact a housing counselor, attorney, or relevant authority for assistance.
Best Practices for Managing Security Deposit Interest
Place security deposits in the right account
Always use a dedicated interest bearing account or escrow account as required. Never co-mingle tenant deposits with operating or other funds. Security deposit management should be an accounting practice that’s approached with care and compliance.
Pay interest correctly
Depending on the state, you may need to:
- Issue interest payments annually.
- Credit tenant interest toward last month’s rent, which is a separate payment made in advance and not part of the security deposit. The security deposit is used for damages or unpaid rent, while last month’s rent covers the final month of tenancy.
- Pay out upon termination of the lease.
Maintain accurate records
Keep detailed receipts, bank statements, and calculations showing how interest was determined. Records should also track any costs deducted from the deposit, such as administrative fees or damages caused by tenants or their animals.
Provide written notice
If states require landlords to disclose the location of the account, send a notice by certified mail or email. Tenants should know where their money is held.
Handle transfers responsibly
If the owner sells a property, both the former and new owner are responsible for ensuring the proper transfer of the full deposit amount, including any accrued interest, to the new owner.
Educate property owners
Many owners don’t realize tenant annually must receive interest or that keeping the excess interest can create liability. Position yourself as their compliance partner.
Why DIY Bank Accounts Don’t Work
It’s tempting for managers to think, “I’ll just open a bank account and place deposits there.” But here’s why that approach is flawed:
- Changing rates: Interest rates fluctuate year to year, making manual tracking error-prone.
- Administrative cost: Calculating interest for dozens of tenants across multiple units can be time-consuming and complex, as each unit may have different move-in and move-out dates.
- Legal exposure: A single failure to remit tenant interest can trigger lawsuits, fines, or claims for treble damages.
- Reputation risk: Tenants talk. A landlord who mishandles deposits risks online backlash and lower retention.
DIY might work for a small residence with one tenant, but for a property management company overseeing multiple rental properties, it’s a liability.
Tools to Simplify Compliance
Modern property management software eliminates these headaches by:
- Automating accrued interest calculations.
- Generating written notices for tenants.
- Tracking when interest payments are due (annually, upon move-out, etc.).
- Keeping financial records audit-ready in case of disputes.
- Ensuring landlord must comply with each state’s specific deposit laws.
These tools help ensure compliance for every rental property and all types of leases managed.
With platforms like Rentable, property managers can:
- Link security deposits to tenant profiles.
- Track funds in interest bearing accounts.
- Automatically generate compliance documents.
This ensures regulatory compliance without relying on spreadsheets or manual calculations.
👉 Explore how modern tools streamline this process in Your Guide to Ensuring a Smooth Security Deposit Refund Process.
Conclusion
Interest on a security deposit may feel like a small detail, but it carries major compliance weight. Across the U.S., states require landlords to handle tenant interest carefully, from setting up proper escrow accounts to issuing interest payments either annually or at the end of a lease.
When returning the security deposit, landlords cannot deduct for normal wear and tear to the premises, only for damages beyond normal use. Tenants are responsible for paying the security deposit and any additional charges as outlined in the lease. Florida law also requires that the deposit be returned within a specific period after the tenant vacates the premises.
The risks of getting it wrong—failure to comply, poor written notice, or misusing funds—far outweigh the minimal interest earned. Property managers who rely on manual bank accounts expose themselves and their clients to disputes, penalties, and lawsuits.
The smarter approach is embracing tools that automate compliance, protect tenants’ rights, and free managers from the complexities of deposit laws. That way, both landlord and tenant can trust the process, and property managers can focus on what they do best—growing their portfolios and improving the property’s financial performance.
