Pros and Cons of Accepting Rent in Advance
Picture this: you live in a world where you don't have to anxiously wait to see if your tenants pay rent on time every month, because they already paid for up to a year of their rent upfront. Advance payments on rent make this possibility a reality.
This is often a mutually beneficial agreement where the tenant and property owner can streamline their rental responsibilities. Rent advances minimize the amount of time needed to communicate, schedule transfers, and follow up on payments. This ultimately makes the rent collection process a lot easier for both the property owner and the tenant.
However, accepting advance rent payments isn’t always a good idea. Depending on who your tenant is and what state laws govern your properties, collecting rent advances could hurt your rental business. In this blog, we’ll discuss the pros and cons of accepting rent payments in advance, the benefits of accepting rent payments upfront, and alternative ways to secure rent payments over an extended period.
What is an advance rent payment?
A rent advance is a payment that covers more than 30 days of rent. Any payments over one month's rent, whether they cover two months or a full year of rent, are considered rent advances. Some property owners encourage advance rent payments from tenants by offering discounts on the cost of several months' rent. For landlords, monthly rent discounts could help secure occupancy and reduce administrative responsibilities -- just make sure a rental discount won’t negatively impact your profit margins.
What is the difference between advanced rent and security deposits?
A rent advance can sometimes be confused with a security deposit, which is an upfront payment required by most property owners when moving into a rental property. Rent advances go strictly toward rent payments, whereas a security deposit goes towards damages and inconveniences to the property or the property owner.
A security deposit can only be used if a tenant damages the unit, violates the lease, or fails to pay rent at some point in time. If there is no reason to use the security deposit, the property owner must return it to the tenant at the end of the lease. If only part of the security deposit was used, the property owner must refund the remaining portion.
Pros of advance rent payments
Real estate investors may prefer rent advances for several reasons. In addition to receiving a large amount of money at once, rent advances allow property owners to find serious tenants for their rental units and simplify rent collection. Here are four key benefits to accepting rent payments in advance:
Rent collection is easier
Collecting rent every 30 days from multiple tenants can be a hassle, especially for real estate investors who don’t live on the property. Most property owners agree that the easier it is to collect rent, the better. By collecting multiple months of rent at once, real estate investors can address maintenance issues and invest in home repairs ahead of schedule. Not only does this enhance the living experience of the current tenant, but it could also accelerate the home appreciation process for the property owner.
Rental vacancies are minimized
One of the biggest risks property owners take on is the possibility of their property remaining vacant during periods of low demand. Receiving advance rent payments secures occupancy for an extended period. This significantly reduces the chances of a vacancy during that time.
Your tenant pool is wider
Another common issue property owners run into is tenants who don’t meet the criteria listed in a rental application. This could delay move-in dates, causing units to remain vacant longer than necessary. Individuals with poor credit or no rental history may be good tenants, but you wouldn’t be able to tell from their rental applications. Allowing non-traditional tenants such as recent college grads to pay for multiple months of rent in advance allows them to be considered as prospective tenants.
You might have a better relationship with your tenant
By paying several months of rent in advance, tenants communicate their interest in the property and alleviate your concerns about whether or not they’ll be able to consistently pay rent. As a result, you’re able to establish trust, which is the foundation of a good tenant-landlord relationship.
Cons of advance rent payments
Renting in advance comes with many benefits, but it also comes with some drawbacks. Knowing the disadvantages of accepting advance rent payments can help you make an informed decision. Here are four cons to accepting rent advances:
Tenants may be unable to make future payments
Accepting rent advances from tenants who have no proof of income or a poor credit score can backfire shortly after. Unless the tenant is paying for twelve months of rent in advance, you’ll eventually need to start collecting rent on a monthly basis for the duration of their lease. Sometimes, a tenant offers to pay for rent in advance with no clear plan as to how they’re going to afford rent every month in the future.
You won’t be able to increase the rent during the pre-paid period
If you’re a short-term rental owner, you probably adjust your daily rates based on peak seasons. By accepting rent in advance on a mid-term or long-term rental, you lock yourself into a specific rate for the duration of the rental agreement. You won’t be able to raise rates until after the pre-paid period is up.
You may need to refund rent in the case of a lease violation
One of the major disadvantages of accepting advance rent payments is that you won’t be able to spend this money freely. If you decide to terminate the lease for any reason, you’ll need to return the portion of the prepaid rent that remains unused. This could be a large amount if the tenant pays several months of rent in advance or the rent is expensive.
You’ll have to adjust your tax reports
Even if rent advances cover rent for the following year, property owners are required to treat it as income for the year in which it’s received. This may result in you having a much higher income one year than the next which can complicate how you pay taxes. Make sure to consult with a tax professional before deciding to accept rent payments in advance.
What else to consider before accepting rent in advance
In addition to the disadvantages mentioned above, property owners should keep in mind that if it sounds too good to be true, it probably is. A tenant willing to pay for up to twelve months or more of rent might not necessarily have the best intentions with your property.
Sometimes tenants paying rent in advance are looking to secure a unit without being disturbed for an extended period. While tenants don’t want their landlords knocking on their door every day, most would understand a landlord's need to check up on the property once a month.
If your tenant is paying a substantial amount of rent in advance with the expectation that you will not be around for months at a time, it may be a sign they plan to do something on the property you wouldn't approve of, such as illicit business or illegal activity.
A tenant who pays a large amount of rent upfront could also be trying to mask a poor tenant history. Always conduct a background check and ask for references from prospective tenants, even when they seem friendly and responsible. It’s better to avoid evicting a problematic tenant than having to resolve a rental dispute in court.
Lastly, accepting rent in advance may be illegal in your state. In some states, you can only collect the first and last months' rent plus a security deposit, while others limit the number of months' rent that can be paid in advance. It’s important to research local and state laws before making any financial decisions regarding your rental business.
How to mitigate the risks of accepting rent in advance
Evidently, accepting rent in advance comes with certain risks. Here are three ways you can mitigate those risks if you decide to accept rent advances from your tenants:
1. Thorough tenant screenings
It’s important to thoroughly screen potential tenants before accepting rent advances. An official background check and personal referrals can help you identify red flags unrelated to finances, such as poor tenant behavior or previous criminal activity. A tenant who fails to maintain a rental property could end up costing you more in property damage and court fees than the amount of rent they’re paying you upfront.
2. Detailed lease agreements
Another way to protect yourself as a real estate investor is to create detailed lease agreements with tenants who pay rent in advance. Including a clause about rent refunds ensures that the refund process is transparent, prevents disputes over returned advance payments, and discourages potential lease violations. If the lease is terminated early, both parties are clear on their rights and responsibilities.
3. Communication and flexibility
Lastly, you need to keep an open line of communication with your tenants. This ensures that expectations are properly communicated and enforced. You should also try your best to be flexible with your tenants whenever possible. The shift from not having to worry about rent to paying it every month can be abrupt.
Alternatives to tenants paying rent in advance
For many investors, the downsides of accepting rent in advance outweigh the benefits. Depending on where you own property, you may not even be able to accept rent advances. In either case, there are other ways you can increase the likelihood of on-time rental payments. Take a look at some of these strategies below:
If the tenant has little experience renting, you may want a parent or relative to cosign the lease. This increases the chances of rent being paid because the cosigner won’t want their credit to be negatively impacted.
Rent guarantor services
If a tenant can’t find a cosigner, they may consider paying for a rent guarantor service. Rent guarantor services cover a tenant’s rent in case they are unable to do so themselves.
Rent guarantee insurance
If neither of the above options is a possibility for the tenant, you may want to obtain rent guarantee insurance. This insurance covers a property owner’s rental income if a tenant is unable to pay. As much as six months of unpaid rent can be covered in a single year, offering landlords a financial cushion during eviction proceedings or while they search for a new tenant.
The bottom line on accepting rent payments in advance
Tenants paying rent in advance can be both challenging and beneficial for property owners. Rent advances provide investors with financial security and convenience while reducing the risk of late rental payments or payment defaults. However, rent advances also come with the added responsibility of managing refund procedures and addressing lease violations.
As a result, accepting rent in advance may not be for everyone. Writing detailed lease agreements and selecting tenants responsibly can help property owners safeguard rent payments, minimize disruptions, and secure a smooth tenancy while accepting advance rent payments. Just make sure that doing so isn't illegal and won't negatively impact your taxable income for the year.