How to Open a Security Deposit Escrow Account (Step-By-Step)

Introduction

Collecting a security deposit is one of the smartest ways to safeguard your rental property, no matter what kind of unit you own.

However, what many smaller or newer landlords may not know is that in roughly half of U.S. states, landlords are legally required to hold security deposits in a separate bank account—and maybe even an interest-bearing one, with interest owed back to the tenant at the end of their lease.

This is not an insignificant barrier to collecting a deposit. It can be time-consuming to go to the bank in person and complete the paperwork required to open a new account, especially if it’s just for a single tenant’s security deposit. As a new landlord, you may know the person you’ve accepted as a tenant and decide it’s not worth the hassle to collect a deposit at all. Some landlords may even collect a nonrefundable move-in fee (which may not be legal in your state) or think it’s fine to keep the deposit intermingled with other funds despite the law.

All of these alternatives are a bad idea. In this article, we’ll explain why all these approaches create more issues than they solve and walk you through how to open a separate security deposit account that fits your state’s requirements, often without leaving your desk.

How Is a Security Deposit Escrow Account Different From Other Escrow Accounts?

In security deposit law, an “escrow account” usually means the deposit is held for the tenant in a separate account, not mixed with the landlord’s other funds. Unlike escrow in a home sale, there’s usually no third-party agent involved. The landlord typically holds the account at a bank on the tenant’s behalf.

In states that use the term “security deposit escrow account,” such as Pennsylvania and Connecticut, the landlord typically deposits tenants’ security deposits into a dedicated account at a financial institution and manages that account, keeping the money separate from rent and personal funds. Other states describe the same idea as an “interest-bearing account,” a “trust account,” or simply a “separate account.” You may also see it called a landlord-tenant escrow account.

Not every state requires a special account. According to Investopedia, “twenty-three states have no escrow requirements or related requirements for depositing or holding security deposits.”

What counts as a compliant account depends on your state. Some states require the account to earn interest, to be held at a bank located in that state, or to be disclosed to the tenant in writing. Always check your state’s statute for the exact requirements before choosing where to hold deposits.

Security Deposit Account Rules in Select States

Here’s how a few states with stricter rules handle a tenant security deposit account. Laws change, so confirm the current statute before you open an account.

Why You Might Need a Dedicated Security Deposit Bank Account

Before we give the step-by-step breakdown, let’s discuss all the reasons why you might need a dedicated security deposit bank account, even if your state doesn’t require it.

Avoid Commingling Funds

First off, keeping your rental funds separate from your personal ones is a key part of financial organization as a landlord in general. If you’re just starting out with investing, this is a fundamental principle that will set your business up for early success.

Simplify Record Keeping

Second, even if there’s no legal requirement to do so in your state, keeping your deposits separate helps you remember that those funds are refundable and still belong to your tenant. You’re only holding them for the length of their lease, and you must follow specific guidelines for what kind of deductions can be made to it at the end of the lease term.

It’s not worth commingling those deposits with rent or other funds when doing so could cause you a headache later when it’s time to return the deposit. Commingling funds also increases the demand for impeccable record keeping, whereas funds in a separate account are easy to keep track of and distinguish.

Interest-Bearing Account Requirements

Third, if you’re in a state where the security deposit is required to be returned with interest, the easiest way to do so is to keep it in a separate, interest-bearing bank account. You shouldn’t try to calculate interest on your own and add it on later. An interest-bearing account for security deposits lets interest build automatically, and depending on your state, some or all of that interest is owed to the tenant, either annually or when the lease ends.

Legal Requirement

Lastly, as mentioned earlier, many states legally require that security deposits are held in dedicated bank accounts, separate from other personal or business funds. If you live in one of these states, you don’t have a choice.

But regardless of whether this is the case in your state or not, keeping a dedicated bank account for security deposits is the easiest way to not confuse those funds with other funds and stay organized, even if you only have one or two tenants.

Tip: Check your individual state’s statutes for the specific language and guidelines about what kind of account you need for security deposits.

What to Look for in a Security Deposit Bank Account

Now that you understand why you need one, what should you look for in a landlord bank account? Here are a few features to look for in a banking option that will make your life easier as a landlord.

• Generous interest rates—A good Annual Percentage Yield (APY) will allow you to earn interest on rental funds.

• Multiple, separate accounts—Look for a bank that will allow you to open and keep multiple, separate accounts for different entities, properties, or units.

• Legal requirements—Check that your banking option adheres to the legal requirements in your state or locality.

• Supports higher-volume transactions—As a property owner, you’ll be dealing with higher-volume transactions. Make sure your bank is equipped to handle these.

• Team access—If you want your property manager, co-owner, or other personnel to be able to access the account, be sure your bank allows for team access.

• Integrated in your software if possible—If you use property management software, the ability to integrate your banking and finances with your software account can greatly simplify your day-to-day management.

For a side-by-side comparison of specific options, see our guide to the best bank accounts for landlords.

How to Open a Separate or Escrow Account for Security Deposits: Step by Step

Here’s a step-by-step guide explaining exactly how to open a separate account for security deposits as a landlord.

• Check your state’s requirements. Confirm whether your state requires an escrow, trust, interest-bearing account, in-state bank, or a set interest rate. This will determine what your options are and what kind of account you’ll need.

• Research your options. Compare online banks, traditional banks, and banking built into your property management software. Think about what’s going to be easiest for you to maintain and most useful for you long-term.

• Choose a banking partner. Choose a bank that meets the legal requirements in your state as well as any personal preferences.

• Gather your documents. Most banks ask for a government-issued ID, your EIN if you own the property through an LLC or other business, and proof of ownership or a property management agreement.

• Open and label the account. Make it clear it’s a tenant security deposit account, kept separate from your operating and personal accounts.

• Deposit tenant funds promptly. Move each deposit into the account as soon as you receive it, and track each tenant’s balance separately.

• Notify your tenants in writing. Many states require you to tell tenants the bank’s name and address, the account type, and any interest they’ll earn.

• Keep records and stay compliant. Track interest, keep a record of any deductions, and return deposits within your state’s deadline.

Why Landlords Bank With Innago

Banking is a fundamental part of real estate investing. That’s why Innago has partnered with banking services to let you set up a fully integrated bank account in about two minutes—straight from your dashboard.

With Innago Banking*, users can send and receive payments immediately, earn up to 2.67% Annual Percentage Yield (APY)**, and avoid monthly fees***. With no routing numbers, forms, or micro-deposit verification wait, you can start collecting security deposits, rent, or just get organized right from your Innago account.

Keep in mind that whether an Innago bank account can serve as your security deposit escrow account depends on your state’s rules, and it may not meet every state’s requirements. Some states require deposits to be held at a bank located in that state, in an account that earns a specific interest rate, or in a certain type of account. Check your state’s requirements before using any account, including Innago Banking, to hold tenants’ security deposits.

Ready for a better way to manage banking?

Try Innago Banking

Conclusion

Keeping security deposits in a separate account protects you and your tenants. In roughly half of U.S. states, it’s also the law. Even if your state doesn’t require it, a dedicated account keeps refundable funds apart from rent and personal money, makes record keeping simpler, and makes returning deposits at the end of a lease much easier.

Opening one doesn’t have to mean a trip to the bank. Check your state’s requirements, pick a banking option that meets them, and keep good records from day one. With Innago Banking, you can open a free, integrated account in minutes and manage deposits right alongside your rent collection, as long as it fits your state’s requirements.

FAQs

What is an escrow account for security deposits?

An escrow account for security deposits is a dedicated bank account where a landlord holds tenants’ security deposits, separate from rent and personal funds. Unlike escrow in a home sale, it usually doesn’t involve a third-party agent. It’s simply a separate account the landlord controls on the tenant’s behalf.

Is a security deposit escrow account the same as a trust account?

A security deposit escrow account and a trust account usually serve the same purpose: keeping tenant deposits separate from the landlord’s own money. State laws use different terms, so check your state’s statute for the exact type of account required.

Are landlords required to keep security deposits in a separate account?

Landlords in roughly half of U.S. states are required to keep security deposits in a separate account. Some of those states also require an interest-bearing account, an account at an in-state bank, or written notice to the tenant about where the deposit is held. Check your state’s security deposit laws for the exact requirements.

Can I keep all my tenants’ deposits in one account?

Many states allow landlords to hold multiple tenants’ deposits in a single dedicated account. You still need to track each tenant’s balance and any interest separately. Some landlords prefer one account per property or unit to make that tracking easier.

Do landlords have to pay interest on security deposits?

Landlords have to pay interest on security deposits only if their state or city requires it. Some states require landlords to pay tenants interest on their deposits, either every year or when the lease ends. Keeping deposits in an interest-bearing account makes this much easier to manage.

What is an interest-bearing account for security deposits?

An interest-bearing account for security deposits is a dedicated bank account that earns interest on tenants’ deposits, which some states and cities require landlords to use. Depending on local law, the landlord may owe some or all of that interest to the tenant.

How do I open an escrow account for security deposits?

To open an escrow account for security deposits, check your state’s requirements, choose a bank that meets them, gather your ID and business documents, and open an account used only for tenant deposits. Then notify tenants in writing where their deposit is held if your state requires it.

What happens if a landlord doesn’t follow security deposit account rules?

If a landlord doesn’t follow security deposit account rules, the penalties depend on the state. In some states, a landlord who mishandles a deposit can lose the right to keep any part of it for damages. In others, the landlord may owe the tenant additional damages or legal fees.

Can I open a security deposit bank account online?

You can open a security deposit bank account online through many online banks and property management platforms, without visiting a branch. With Innago, you can open a free bank account in about two minutes, straight from your dashboard. Before using any online account for security deposits, check that it meets your state’s requirements, such as using an in-state bank or an interest-bearing account.

Important disclosures

* Innago is a financial technology company and is not a bank. Banking services are provided by i3 Bank, Member FDIC. The Innago Visa Debit Card is issued by i3 Bank pursuant to a license from Visa U.S.A. Inc. and may be used anywhere Visa cards are accepted.

** Annual Percentage Yield (APY) is variable and subject to change after account opening. Rate is compounded monthly and credited monthly.

*** No account or domestic transaction fees. Some foreign transaction fees may apply in limited circumstances.