Real Estate

Security Deposit Alternatives for Landlords and Tenants

Security deposits are typically essential for landlords to protect their property in case of damage. But coming up with the first month’s rent, pet fees, utility deposits, and moving costs can make it challenging for tenants to pay a security deposit.

Rather than traditional expensive cash deposits, security deposit alternatives are cost-friendly options. Additionally, some states now require landlords to accept alternatives to security deposits.

All landlords know the value of security deposits. You can use the money to pay for repairs, appliance replacement, unpaid rent, or other expenses that are the result of a tenant’s actions. Security deposits are also a way to encourage tenants to care for the property.

However, many responsible tenants find it difficult to get the required cash for the upfront deposit. Even before the pandemic, a study found that the vast majority of Americans lived paycheck to paycheck, meaning they were unable to put aside savings.

For renters, this can make it impossible to find suitable accommodation. A 2017 Federal Reserve study found that 40% of people would find it challenging to cover an unexpected expense of $400—not to mention a security deposit of $1,000+.

For landlords, high security deposits can mean it takes longer to fill vacancies. However, it’s risky to rent to someone struggling to make ends meet without an upfront security deposit. This is where security deposit alternatives can provide a solution.

What is a security deposit alternative?

A security deposit alternative protects landlords financially in the event a tenant causes damage but also makes renting more affordable for tenants. Popular security deposit alternatives are surety bonds, pay-per-damage arrangements, credit authorization services, and lease insurance.

What is Renter’s Choice law?

Although alternatives to traditional deposits have been around for some years, some states require that landlords accept alternatives. For example, Renter’s Choice laws require landlords to offer alternative options.

Depending on the state, here are some examples of what some city councils require from landlords in addition to the traditional deposit:

  • Pay the deposit in at least three monthly installments
  • Take out rental security deposit insurance
  • Limiting lump-sum security deposits to a maximum of half of one month’s rent

More on security deposits from BiggerPockets

The pitfalls of the traditional security deposit

The main issue with the traditional deposit is its cost—typically between one and three month’s rent. Many tenants don’t have that extra cash. Although the money is returned to the tenant if there are no lease violations, the money sits in a bank account. So there are hundreds of millions of tenants’ dollars idly sitting in cash security deposits.

The advantages of security deposit alternatives

In most cases, security deposit alternatives are win-win solutions for landlords and tenants. Landlords get the same—if not more—protection as offered by security deposits. Tenants don’t have the financial burden associated with renting a new home.

Fill vacancies faster

Because deposit alternatives aim to lower the deposit, it’s easier to find tenants. The initial rental costs are lower, so you can attract more renters. In addition, you stand out from the competition because your options are more attractive to potential tenants.

It’s also easier to accept tenants with a lower credit score. For example, security deposit replacement schemes allow people with low credit scores to use their service. This means that you can accept tenants who have an excellent financial status but a poor credit rating.

Protect your property better

In many cases, replacing the traditional security deposit with an alternative is a smart move to protect your property. For example, deposit insurance can cover damage to your property for more than a traditional deposit would. Some standard insurance plans cover up to $5,000 in damages—far more than you could require for an upfront security deposit.

Also, insurance premiums can be based on the renter’s history, pets, credit history, and other factors.

A popular alternative deposit is a surety bond. This is a fraction of the cost of a typical security deposit. The tenant pays a fee, which can be less than 18% of the usual cash amount. Or there is a small monthly charge while the tenant is in the unit. Then, if there are any damages, the surety bond issuer pays for the cost. This means that you don’t have issues to resolve with the tenant.

Give renters a choice to suit their circumstances

Giving tenants the choice of alternatives to cash deposits makes you a better landlord. The upfront affordability for renters is an advantage for many tenants. You also give tenants more control of their money.

Some tenants may opt to pay the traditional security deposit. However, many will choose from the various alternative security deposit options available. In a changing economic climate, offering options to tenants can make your rental property more attractive from a financial point of view.

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What are the disadvantages?

For most landlords, security deposit alternatives are a way to attract more tenants and minimize vacancy rates. For tenants, these alternatives make rental housing more affordable. Tenants can move into a new home for a small sum or a monthly fee, and the landlord is fully protected.

But are there any disadvantages to consider?

For tenants, the fact that they don’t get their bond fee back is a sticking point. Unlike a security deposit, they don’t get their money back, even if they leave the place spotless. In addition, in the case of damage or unpaid rent, they must reimburse the bonding company for the damage. So, in the long run, a surety bond can be more expensive for tenants.

Another issue that tenants have with surety bonds is that they may think they purchased security deposit coverage. This can cause a shock to the tenant if you claim damages, and then the surety company bills them for it.

You need to inform each tenant of the type of deposit alternative on offer and its implications if there are damages to pay for.

Should you accept security deposit alternatives?

The rental industry is slowly moving toward accepting alternatives to traditional security deposits. Deposit alternatives make it more cost-effective for tenants to move in. Also, as a landlord, you are protected against unpaid rent and damage to your property.

For most landlords, surety bonds, deposit insurance, or rent guarantee insurance are excellent alternatives to protect against financial loss caused by a tenant.

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