Security Deposit Replacement Products - The Traditional Security Deposit May Soon Sharing Space with New Alternative

person A.J. Johnson today 05/29/2022

The standard practice of paying a month’s rent (or more) is being challenged in the multifamily marketplace with new alternatives to the cash security deposit.

These new products represent a gamechanger for the way landlords protect themselves from potential damages and non-payment of rent. An estimated $45 billion currently sits in security deposit accounts. These new products have the potential to free up much of this money for more immediate uses. However, there are pros and cons to these new products.

  • Products being sold include surety bonds, insurance policies, and rent guarantees. Tenants are charged nonrefundable monthly fees - usually $10 to $30 - instead of a refundable upfront lump sum.
  • Critics of these new products claim that tenants can wind up paying a lot more than they would with a refundable security deposit and that the products do not always offer the same protections.
  • While the products are sold to renters, the companies are working for the landlords, and it’s not always clear who takes the lead in resolving disputes.

There is a growing movement in many cities called "Renters Choice," which is pressing cities and states to relax security deposit laws allowing greater potential for the new products, which are known collectively as "security deposit replacements," or SDRs. The first two laws of this type have been passed in Cincinnati and Atlanta.

How It Works

Companies like SureDeposit, TheGuarantors, Rhino, LeaseLock, and Obligo sign up property owners. Each product has a different system, so owners have a variety of choices. The target tenant market is not generally people who cannot afford a deposit, but people who prefer to use their money elsewhere or do not trust the landlord to return it.

Some companies - such as Rhino - offer security deposit insurance. The renter purchases the insurance for the landlord’s benefit in case there is unpaid rent or damages. For example, a tenant with a $2,000 monthly rent would pay a monthly fee of $20 or so for a policy that would pay the landlord as much as $2,000 if there were issues when the tenant moved out. If the damages total more than $2,000, the tenant is billed by Rhino.

One of the main weaknesses relative to regular security deposits is the complexity and cost of maintaining the accounts. Also, landlords often have trouble tracking down tenants to return the security deposit after they move out. And of course, in affordable housing complexes, new applicants often have a tough time coming up with the money for a deposit. In the affordable housing realm, one of the primary benefits of these products is to help people get into the housing that they can otherwise afford - were it not for the upfront costs.

However, tenant advocacy groups are not fully onboard with the alternatives. They point out that security deposits - while imperfect - offer legal protections that are lacking in these new products. The deposits are refundable while the cost of the new products is an actual cost - that will not be recouped.

While these products do offer viable alternatives to traditional security deposits in many cases, landlords considering offering these options to applicants should be aware of potential pitfalls. Tenants who can afford lump sum deposits will usually be better off providing a refundable deposit than paying a nonrefundable monthly fee. Also, most affordable housing programs (e.g., LIHTC) will have to offer this service as an option and not require that applicants use the product. Otherwise, the fees associated with the insurance will be considered rent.

All-in-all, it seems worthwhile for landlords of affordable rental properties to at least look into the possibility of offering an SDA to applicants. While pricing varies geographically, the cost of one of these products can range from $96 to $262 for a $1,400 per month rent. This is clearly more affordable to many applicants than a $1,400 security deposit, but it is nonrefundable.

As noted already, the key to offering products of this type is to ensure that applicants fully understand that they have an option to provide a traditional security deposit or use of the alternate products. With this option available, affordable housing operators may well be able to expand the market of eligible renters who can afford the upfront costs of project entry.

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