Last year, we shared some tips for property managers and owners on managing security deposits. Because many laws have changed at the state and local level since then, we invite you to check out Buildium Laws, our directory of information on security deposit law and other laws at the state level.
You just showed a unit to a young couple, and they loved it. They both have steady jobs. Their background check looks great, their credit check is rock-solid, and their references are excellent. By all appearances they’d make model tenants.
But there’s one hitch: They just moved to the area, and they just started new jobs. You want to get the apartment rented, of course, and they’re ready to sign a lease. But they just don’t have the extra two months’ rent on hand your company requires as a security deposit.
It would be a shame not to rent the apartment. But, of course, as a manager and an agent of the property’s owners, you have to cover your risk. What can you do? Surely there must be an arrangement you can make.
It turns out there is: Have the tenant post a surety bond. While not well understood by most consumers, the bond arrangement can be a viable alternative with advantages for the property management company and tenant alike?
What is a Surety Bond?
A surety bond is a form of insurance that provides a contractual promise: If the tenant fails to abide by the term of their lease in some way (property damage, for example), the bond company stands ready to compensate the property managers/owners up to the limits of the bond.
If you’ve ever had to bail someone out of jail, you have an idea about how bonds work. Bail may be set at $1,000, but you only have to put up $100 in order to get the bail company to bail out the detained person. The bail company puts up the rest, believing they’ll get refunded and profit when your friend or relative shows up for the hearing. (If the detainee skips the hearing, they forfeit the bond and the bail company goes after them!)
In the residential apartment industry, surety bonds work similarly: The renter puts up a percentage of the required deposit (often 17.5 to 20 percent of the total sum). If you as a property owner have a claim against the tenant (one that would otherwise count against the security deposit), then you place a claim with the surety company. The protection lasts for the length of the lease, or up to five years, whichever comes first. If more money needs to be collected from the tenant, the bond company will take care of that collection.
While surety bonds were relatively rare a decade ago, economic realities prompted land owners to look for ways to make it easier for struggling families (millions of whom had just been foreclosed on after job losses and were now looking to rent) to deal with move-in costs. Early adopters included California, Florida, and Nevada — all hotspots in the mortgage crisis of 2008-2010 — but surety bonds have been used in many markets well before that downturn several years ago.
One prominent nationwide insurance company that issues surety bonds is Assurant, though there are others, and there are many independent agents that will broker surety bonds for your tenants.
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Seven Advantages of Surety Bonds
On the other hand, a surety bond company offers a number of benefits to property managers. Here are seven reasons to offer bonds as a security deposit alternative:
- Prompt payment: Surety bonds assure payment within two weeks or so, in most cases. You don’t have to wait a certain number of weeks to get compensated. A security deposit normally comes with a waiting period.
- Lower move-in costs: Without the burden of a large security deposit, surety bonds can help you fill vacancies faster.
- Less burden on the property manager: The management company/property owner is removed from the collection process and, in most cases, from litigation over disputes arising from the return of a security deposit.
- Gain competitive advantage: Being open to offering surety bonds could help you market your property. For example, you can advertise the property with the words “No security deposit necessary for qualified renters!” In some areas, this can be a decisive competitive leg up.
- Simpler financial processing: It’s a hassle to open a separate trustee or escrow account with your bank for every new tenant. It takes expensive man-hours to process. Surety bonds don’t require anything like that on your part.
- Lower bank fees: You typically have to pay an account management fee each month to your bank on smaller accounts. This eats away at your deposit over time. With a surety bond, this isn’t an issue. Additionally, you don’t have to track and pay out tiny amounts of interest on security deposits.
- Additional screening: Surety companies do background checking themselves before they agree to issue a bond.
Disadvantages of Surety Bonds
The downside is you do lose that important screening function that collecting a full security deposit can provide. If the tenants can’t come up with a security deposit, it also may be tough for them to pay rent on time. Additionally, if there’s no prospect of the return of a security deposit, the tenant has that much less incentive to keep the property in good shape.
And there is a disadvantage for tenants, too: They don’t get the money back at the end of the lease, even if there’s no damage to the unit.
Additional Tips on Surety Bonds
For property managers in expensive cities where security deposit requirements are high ($5,000 and up is common in San Francisco and New York City), surety bonds can be lifesavers to the lessor and lessee alike. This is also true for college students and other young people just starting out or who are working lower-wage jobs or raising families on a single income. Many families just don’t have the cash on hand that it would take to move. Surety bonds may, however, make less sense in lower-cost areas.
From the tenants’ point of view, it works best if they intend to stay for several years. They can cover the bond with a single premium of about $175 per thousand dollars of coverage. If they move every year, though, it’s much less advantageous for them.
Many smaller landlords view these surety bond arrangements with trepidation. But they may make better sense for larger properties or residential management companies. For best results, be sure to document any damages carefully prior to forwarding a claim. When your counter party is an insurance company, rather than an individual tenant, the company may not be as inclined to just pay the money on a questionable claim and move on.
If accepting surety bonds gets more people into units, though, whatever the downsides are, they can be more than made up for in lower vacancy rates.
A final pro tip: Want to get more renewals from good tenants? Offer them a chance to swap their security deposit for a surety bond. Then you can give them hundreds or thousands of dollars, and they pay out a fraction of that for a surety bond and keep the rest. Now they have an emergency fund to pay rent if they find themselves in a tight spot. And because of your generosity, they’ll very likely sign a renewal. It’s a win all around, if the tenants are willing to sacrifice the amount of the premium.
Have you offered surety bonds as alternatives to security deposits? Have you found them helpful or too much of a risk? Please leave a comment below and let your fellow property managers and owners know about your experiences.Read more on Accounting & Taxes