Landlords must set up escrow accounts to hold tenants' security deposits if the accounts are required by the laws of the municipalities or states where the rental properties are located. A landlord's escrow account is a bank account that holds security deposits in a neutral location so that the funds are accessible when tenants move out.

Not every state requires an escrow account, but some municipalities require the accounts even when the states do not. States that don't require a separate escrow account often require landlords to place security deposits in a regulated financial institution. 

Some states require security deposits be held in escrow, but also that tenants be paid the interest-earned on the account and be made aware of the location of the account.

Landlords who live out of the area should set up escrow accounts at banks located in the same states as their rental properties, and they should note whether local laws require the accounts to bear interest. Even when local laws don't require the establishment of escrow accounts, landlords may wish to set them up to avoid mixing their personal finances with their tenants' security deposits.

Key Takeaways

  • State and municipality law dictates when and if landlords must hold a tenant's security deposit in an interest-bearing escrow account. 
  • Many states don’t require security deposits be held in escrow. 
  • Some states have criteria that dictate if escrow is required, such as the amount of the security deposit and the number of properties that the landlord owns.

States That Require Escrow

States that require escrow accounts dictate when landlords can take money out of the accounts, and some states allow landlords to recoup late rent from the accounts. States also regulate when landlords must return security deposits after tenants move out.

Many states don’t require funds be held in an interest-bearing escrow account, however, many states have specifications on whether the account must earn interest based on the amount and the number of rental units owned by the landlord. Twenty-three states have no escrow requirements or related requirements for depositing or holding security deposits.

Escrow accounts sometimes also come into play with rental properties when tenants feel that landlords have neglected the properties, creating unsafe living conditions. If a dispute of this type develops, some states allow tenants to pay rent into escrow accounts rather than directly to the landlords until the matter is resolved.