What is a surety bond?
A bond is not a deposit. A surety bond is a product that a prospective tenant can purchase in lieu of a traditional security deposit. The bond is normally nonrefundable and costs significantly less than a security deposit, thus reducing the tenants move-in costs. I have heard it presented as a type of insurance policy to a prospective tenant. I understand that most, if not all, of these products are underwritten by insurance companies. My research indicates that there are a couple variations to this type of service depending on the company.
Does a surety bond relieve the tenant of any financial responsibility to the landlord?
No, it doesnt. A surety bond is usually an insurance-type product, but it holds the tenant responsible for any debt that is owed the landlord. Depending on how the service is structured, the tenant who leaves owing a balance will be pursued by either the landlord or the surety company for the amount owed.
Do tenants who purchase a bond and later leave the property owing a balance generally pay what they owe?
My experience is that collecting from a previous tenant who bought a surety bond is more difficult than collecting from a tenant with a traditional deposit.
Why are tenants who purchase a surety bond less likely to pay than those who pay a deposit?
There a couple possible reasons for why these previous tenants are more likely to refuse to pay their balance. In addition to the usual objections, they often feel they do not owe anything because they had an insurance policy. Even though the bond sales literature and contract state that the tenant is liable for any charges when they move out of the rental unit, the tenant often understood something different when they purchased the bond.
Imagine being a fly on the wall in a leasing office. Here comes Mr. Prospect looking for a home to rent. Funds may be tight and he is looking for the best deal he can find. He is greeted by the smiling landlord or leasing agent anxious to rent an empty unit. He is presented various floor plans, locations, and lease options.
How much is the deposit? he asks. Well, Mr. Prospect, you have two options: you may pay a traditional deposit of $1000 or you may purchase a nonrefundable bond for $100.
What did the prospect hear? Often, he heard $1000 (thinking, Wow, thats lot of money!) or he heard blah, blah, blah $100 (thinking, thats not much). He is also probably thinking that moving is expensive and that this is a way he can save money on the move.
Even if the details of the bond were fully disclosed at the time the bond was purchased, often the new tenant could not explain those details. If the word insurance was used at the time the bond was sold, this only strengthens the tenants objections to paying anything he owes the landlord when he moves out. His experience with insurance is his car insurance. He pays his car insurance premium so that if he has an accident, he wont have to pay the damages; the insurance company pays. In the average tenants mind, the deposit bond he purchased to rent his apartment is no different. He bought the bond, and although he may have damaged the apartment, he feels he is covered because he bought the insurance.
I have no way of knowing for sure, but another good question to ask related to this process is: How well does a tenant who believes they have an insurance policy on damage to their rental care for the unit itself? It is plausible that a less than desirable tenant may see the purchase of what he feels is insurance as an excuse not to take care of his rental unit.
Surety bonds are relatively new to the residential housing industry. If the use of this service fits your business model, I encourage you to use it. However, from a collection standpoint, I strongly urge you to explain in detail to your new tenant what the bond is, how it works, and what his financial responsibility will be. An extra five minutes explaining this may save you thousands of dollars after the tenant moves out.
Another security deposit alternative is LeaseGuarantee. LeaseGuarantee sells a contract valued at $1,000 to $10,000 for a nominal fee (fees are one-time, start as low as $100, and are based on the tenant’s credit). What’s unique about LeaseGuarantee compared to other security deposit alternatives is that they have no minimums and everyone will qualify for a contract. The LeaseGuarantee Analyzer is included free with all AAOA tenant screening, simply run a tenant background check and get instant results as to the fee for the contract.
American Apartment Owners Association offers discounts on products and services for landlords related to your real estate investment including landlord forms, tenant debt collection, tenant screening, insurance and financing.