Security Deposit Alternatives
Security deposit restrictions by statutes and ordinances regulate the landlord’s policy and practice for the maximum amount of security deposit that can be collected, the time period for deposit accounting and return of available deposit funds, security deposit accounting disclosure requirements, and mandates for deposit installment plans.
Recent legislative changes in many jurisdictions requiring lower deposit amounts and utilization of installment payments for security deposits have been implemented as means to address housing affordability. With higher rents and, accordingly, higher rent-based security deposits, renters may struggle to afford the move-in expenses of screening and application fees, first month rent, last month rent, and security deposit. A large dollar amount due at lease signing can reduce the size of the applicant pool and potentially extend vacancy down-time. With changing regulatory requirements and market conditions, a landlord will need to consider many factors in setting his rental policies for rents and deposits.
There is movement by some jurisdictions to require security deposit alternatives and security deposit replacement options to expand choices for renters to manage their financial obligations for security deposits. A landlord will need to conduct due diligence to determine the applicable legal compliances for security deposit options for the location of his rental property to ensure understanding of those requirements. Due diligence is also required to research deposit models to make an informed business decision on the best deposit alternative/replacement option for the landlord’s property operations. A landlord should have good knowledge of the particulars of his selected deposit option in order to educate the renter on how the option works and what the renter can expect if choosing that option.
Renters Choice legislation
In 2020 Cincinnati was the first city to require landlords to accept alternatives to a traditional security deposit. Cincinnati’s Renters’ Choice law applies to all landlords with 25 units or more and offers three security deposit options:
- an insurance premium, in which the tenant pays a small monthly, nonrefundable fee instead of an upfront deposit;
- an installment plan to spread the deposit equally over six months (or more if the landlord and tenant agree); or
- a reduced security deposit, paid upfront, of no more than one-half the monthly rent.
Columbus has passed a Renter’s Choice ordinance that if a security deposit is required, prior to entering a rental agreement, a tenant required to pay a security deposit, shall either pay the required security deposit in full or select and subsequently fulfill one of the following rental security deposit payment alternatives:
- payment of the security deposit over a series of no fewer than 3 monthly installment payments, which installments shall be due on the same day as the monthly rent payment and which may be paid together with the monthly rent payment in a single transaction,
- payment of the security deposit over a series of no fewer than 6 monthly installment payments, which installments shall be due on the same day as the monthly rent payment and which may be paid together with the monthly rent payment in a single transaction.
The ordinance does not apply to any landlord with fewer than 5 rental units.
The city of Atlanta passed a renters choice ordinance whereby renters can request rental security insurance or monthly installment payments for their security deposit obligations .The ordinance applies to landlords with more than 10 rental units who require a security deposit that is more than 60% of the monthly rent amount. The ordinance allows renters the choice of paying their security deposit in three monthly installments or through third-party rental security insurance. Renters still have the option to pay the traditional cash security deposit collected at lease signing.
State legislation examples
The Texas Property Code allows landlords to give their tenants the option to pay a monthly fee with their rent instead of paying a security deposit. Under this law, the landlord can choose to purchase insurance to protect the rental with the monthly fee. If the landlord chooses to do so, the fee cannot be “more than the reasonable cost of obtaining and administering the insurance” purchased under this law. If the landlord files a claim under the insurance purchased with this fee, they cannot make the tenant pay them for the same damages.
In the state of Washington, upon written request from a tenant a landlord must generally permit the tenant to pay any deposits, nonrefundable fees, and last month’s rent in installments. In all cases where premises are rented for a specified time that is three months or longer, the tenant may elect to pay in three consecutive and equal monthly installments, beginning at the inception of the tenancy.
Other states that have passed legislation addressing security deposit alternatives and deposit replacements include Delaware, Florida, and Nevada. Other states have pledged support or have proposed legislation for options to traditional security deposits.
Deposit Alternatives
Alternatives to traditional cash security deposits may include deposit options such as surety bonds, deposit installment programs, guarantor programs, and billing authorization services.
Surety Bonds
The surety bond model of deposit alternatives may be the most familiar product to landlords. While specifics of surety bond programs may vary among a number of service providers, in general a surety bond program is a contractual agreement between three parties, the landlord, the renter, and the surety bond provider. The renter purchases a bond equal in the amount to the security deposit required by the landlord. The bond is held by the provider in the event that a landlord needs to make a claim against the renter for a lease default. The renter pays a non-refundable premium, typically a small monthly fee, or a one-time premium that is usually a small percentage of the total insured amount as specified by the landlord. The premium is in addition to the stated monthly rent. The premium is the renter’s promise to comply with lease terms and conditions; i.e., to pay full rent and not damage the rental property. Coverage provided by the bond is the same as would be covered by the cash deposit, e.g., property damage, lost rent, but not normal wear and tear.
The provider holds the bond that guarantees coverage of the landlord’s risk up to the value of the bond. The renter is able to move in without a large cash outlay, yet the landlord can still protect his business interest. If the landlord suffers a loss and files a claim, the provider uses the bond to cover and pay out the claim directly to the landlord. The provider will then seek repayment from the renter. Rather than the landlord deducting charges for tenant-caused repairs from a deposit already paid, the renter gets a bill directly from the carrier.
Security Deposit Replacement
A security deposit replacement option is lease insurance which gives the renter a deposit-free move-in. The renter avoids the expense of a security deposit payment at move-in and pays a small monthly deposit waiver fee in addition to his monthly rent. The property manager insures his property against rent loss and damage, generally at a higher coverage amount, while reducing administrative costs of traditional deposit collection and handling. Depending upon the service provider, lease insurance may be an option only offered at this time to large rental communities. Due diligence will be needed to research providers, program details, and service areas.
Security deposits are required by a landlord to protect his business from property damage and lost rents The model or methodology used to protect the business is dependent on business necessity and legal compliances.
While security deposit options legislation is being considered, pending, or has been recently enacted in some rental markets, it should be noted that security deposit option services offering alternatives for traditional deposit collection are not new to the rental market. Independent landlords with small to mid-size properties have for some years voluntarily contracted with deposit services providers to offer such options to their renters.