Deposit-replacement products – are they good or bad for landlords and tenants? In writing this article, I am nervous of falling on either side of the fence, for several reasons. First, I am the CEO of mydeposits, one of the tenancy deposit protection schemes authorised by the government. Second, I am not a letting agent, so I have limited knowledge of the financial pressures of letting properties quickly and painlessly. Finally, I am not a prospective tenant struggling to afford the costs of renting a property.
What I am, however, is a relatively educated businessman who has worked for 30-odd years in insurance, tenancy deposits and consumer complaints. I would like to think that my credentials allow me to express a fair opinion on the trend that has been dubbed deposit-free renting. For me, the reality is simple: this should be good for all parties.
For instance, deposit-free renting can enable tenants to enter into a letting agreement without having to find the upfront cost of a deposit; the physical deposit is replaced with a guarantee that ensures that the landlord will not lose out financially if the terms of the tenancy are proven to have been breached. Decisions about whether the landlord's claim is valid or not should follow established processes of traditional deposit-protection schemes.
The landlord can in turn widen their marketing to a broader range of tenants, financially speaking, which could help let the property quicker. At the end of and presumably during the tenancy, the landlord can also make a claim from the deposit guarantor if something should go wrong and the tenant can't or won't pay. Meanwhile, the letting agent can also benefit from the property being let quicker, thus increasing revenue, and also earn a referral fee or commission for each deposit-replacement product they sell.
But there is the other side of the coin to consider. The forthcoming ban on charging fees to tenants clearly states that, in order for these products to circumvent that ban, the tenant must be provided with a choice as to whether to pay a traditional deposit or purchase a guarantee or policy. There is an assumption that the tenant will have made their decision and adequately researched the deposit-replacement market before entering into a tenancy, and that they know how each of these products works.
This sounds positive, and the owners of these schemes will willingly go on the record to say their agents also understand exactly what they are selling. Bear in mind, however, that there are already three different deposit-free models on the market – insured, guarantee and warranty – and this is without individual agents promoting their own non-insured guarantees. In reality, the tenant is going to ask the agent how it works, or the agent is likely to offer a single product model, so the onus is on them to explain the workings and ensure the tenant makes an informed purchase.
In most cases, though, the agent is actively selling the benefits of having no deposit against paying one. Add in the financial incentive provided to the agent, or in most cases the individual property manager, and the whole context of the sale changes. Will the right questions be asked and answered?
These include questions such as: is the product suitable for the tenant, taking into account their financial circumstances? Have the benefits and exclusions of the guarantee been fully explained to them – specifically that they will remain responsible for damages and unpaid bills at the end of the tenancy? Are these unsuspecting tenants told that they are not actually purchasing an insurance policy that covers them, rather that they are paying for a product that simply allows them to rent a property without paying a traditional deposit? Do they know that everything else is down to them, and that if they fail to pay what is owed then their credit score can be affected and they won't be able to purchase such a product again or worse still that they may have trouble gaining credit in the future?
It is not just the tenant who needs to be aware of the small print, because the letting agent has to explain everything to the landlord as well. On the face of it, these products sound great for landlords: if the tenant can't or won't pay damages or rent then don't worry, the guarantor will stump up for the losses at the end of the tenancy and chase the tenant thereafter.
However, has the landlord been advised that they will have to make a formal claim for even the smallest of deductions if the tenant won't pay for it at the end? It won't be long before the tenant cottons on to this and just refuses to settle up, leaving the landlord to foot the bill for the loss themselves until their claim is paid.
I am not worried about the flexibility and adaptability of these products – insurance or guarantees work very well when sold correctly, which is why the Financial Conduct Authority (FCA) asks sellers of insurance and guarantees to meet very high standards. Rather, my concerns lie at the doors of letting agents and the way they promote and sell these products to unassuming tenants who just want to move into their dream home.
The providers may be FCA-regulated – although many are not – and following the rules, but are their appointed representatives, that is their letting agents, subject to the same stringency? Are the agents required to undertake the same training and compliance checks that insurers and brokers do? In a lot of cases, I doubt it. Many of us remember the mortgage guarantee and guaranteed rent scandals of the 1990s and mid-2000s, where estate and letting agents fell foul of financial regulations by mis-selling such products. We must be careful to prevent a recurrence of such scandals.
In addition, if a tenant cannot afford a deposit and the agent offers them the choice of not renting the property or purchasing the agent's chosen replacement scheme at a higher cost than they could purchase another elsewhere, would that agent be in breach of the fee ban? And what about product renewal fees? Such scenarios need challenging.
In my ideal world, letting agents would not get involved in selling these products. Instead, the tenant would arrive at the agent and say they either have the deposit amount, or they have conducted independent research and purchased a deposit-replacement product. In this scenario, the tenant has the choice over which product to purchase, and the provider of the product, who is fully FCA-compliant, does the selling, explaining clearly both the benefits and pitfalls directly to the tenant. The product provider is therefore responsible rather than the letting agent. Unfortunately, too many of these new providers are marketing these products as a means of revenue replacement for their agents, who may face shortages in their finances when the Tenant Fees Act 2019 comes into play later this year.
To return to the original question – are these products good or bad for the property market? When sold correctly, they will definitely open renting up to more individuals and families who could not hitherto access a decent home. That must be a good thing. The key words, however, are "when sold correctly"; agents should be conscious that pushing particular products could be challenged by the FCA, which is very keen to promote choice and fairness.
Questions will be asked: is one brand of product better than another? If the tenant has already sourced a product that provides the same benefit as the one the agent is promoting, should that tenant be excluded from using it? Should a traditional deposit be promoted when the cost of the replacement product is clearly disadvantageous to the tenant, especially in short-term lets? What if the tenant is evidently in financially challenging circumstances? Will there be background checks on the tenant to see whether they have used and abused one of these products before? Should an agent be allowed to promote the option of returning the landlord's security to the tenant and replacing it with one of these products? All of this needs more debate.
As a provider of traditional tenancy deposit protection, I am confident that this will continue to be the preferred method of surety. There are some 4.5m deposits taken by landlords and agents in protected schemes, of which more than 40 per cent are taken by landlords directly. As deposit replacement products are not currently designed for them, this represents a whole new set of challenges.
I therefore believe that taking a customary deposit has more benefits for both parties than these new products can ever provide. With a traditional deposit, the landlord has an amount of cash that is easily accessible should things go wrong and the property needs to be prepared for the next let. The tenant is interested insofar as, if they keep to the terms of the tenancy agreement, they will get their deposit back. Meanwhile, the agent continues to act for both parties in a fair and transparent way, free from regulatory hassle and threat.
For those individuals who maintain that deposits are the one barrier to entry for many tenants due to their cost, here is an interesting statistic: across all tenancy deposit protection schemes, the average deduction made from a deposit is less than the equivalent of one week's rent. So why do landlords feel the need to take between four and six weeks' worth as a deposit? Clearly the government also felt that deposits are too large and is soon to cap them at five weeks as part of the 2019 Act.
Interestingly, a week's rent is the same amount as the fee to purchase one of these deposit replacement products. Is one solution, for the landlord, to take a lower refundable deposit and then purchase a rent guarantee and legal expenses product to protect against rent not paid by the tenant?
The tenant benefits in terms of cost and has an interest in fulfilling the terms of the agreement, while landlords and agents have control over the deduction process with a rent guarantee product that will offset unpaid rent and dilapidations and is already proven in the marketplace. Food for thought.
Related competencies include: Leasing and letting, Legal/regulatory compliance