Disrupting The Security Deposit With Insurance

Affordable housing in many American cities has reached crisis levels. For those looking for officially government-certified affordable housing, the average time on the waiting list is two years, though in some U.S. metros that time can extend to a decade and beyond. And that is if the list is even open — in cities like New York, Los Angeles and San Francisco new applicants can’t even join but for open periods that occur every few years.

And even outside the world of officially-designated affordable housing, the hunt for stable, reasonably priced housing in many American cities is increasingly a perilous one liable to end in failure. On average apartment rent rates have gone up about 36 percent in the last decade according to retail data firm Yardi Matrix, and in particularly desirable marketplaces like Denver, Austin and Seattle rents have gone up by more than 70 percent.  As of 2020, about 25 percent of American renters are paying over 50 percent of their monthly income in rent, according to Apartment List.

That high debt-to-income ratio brought on by those rising rent rates has consequences for affordability once a consumer has moved in — but perhaps even more pressing and adding to the ongoing affordability crisis in an expanding number of desirable urban areas is that rising rental rates make it harder for consumers to move in the first place because they are unable to afford the security deposit.

The average security deposit in the U.S. is generally a charge of one to two months’ rent, and the average rent in the United States is slightly over $1,400 per month. And of course averages can be misleading — in Manhattan that rent average is over $4,000 a month, while in Wichita, Kansas (the least expensive market in the survey) rents are still well below $1,000 at $639 a month.

But in the U.S., where the average customer reports having insufficient cash or credit resources to cover a $400 emergency expense, being asked to cover $1,400 to $2,800 on average in additional costs to move into a new apartment creates a real and significant financial burden.

Moreover, even if one takes low income earners and renters out of the equation, the problem still persists. According to a recent analysis of bank accounts and transactions by the JPMorgan Chase Institute, the typical middle-income household can handle that $400 emergency — but still only has $3,000 in liquid assets.  Their savings might cover the security deposit — barely, in some cases — but will more or less be consumed.

In the wake of the rising epidemic of a lack of affordability in housing, a series of startups have risen to offer an alternative solution to the security deposit problem for renters with what basically is an insurance product. Firms like Jetty, Rhino, TheGuarantors and Insurent all have slightly varying structures but all allow consumers to pay a much lower fee for insurance on the apartment, as opposed to a large cash deposit upfront.

The renter then either pays a monthly fee for the insurance for the term of their lease or a one-time payment to the third-party insurance provider. At the end of the term, the startup then takes responsibility for any damages or claims against the lease for the tenant.

An honest landlord needs a security deposit to protect themselves against a bad thing that may or may not happen, Paraag Sarva, CEO and co-founder of Rhino, told PYMNTS in a discussion last year. That, he noted, is literally a textbook case for an insurance product — and the idea that instead a customer is leaving a few thousand dollars in cash on the table for a few years is antiquated and totally out of step with the rest of their transactional lives.

“Consumers would find it odd to leave a $5,000 cash deposit to rent a car,” he said. “Yet when you rent an apartment, which [involves] bigger checks, bigger amounts of money, people are so ingrained to think, ‘Of course I have to leave a cash deposit to protect against something that might or might not happen.’”

Moreover, Joe Ben-Zvi, managing director of TheGuarantors, told PYMNTS in an email that an insurance product is ultimately better protection for a landlord in case of damage. While the funds collected from the renter can feel quite high, when it comes to repairing serious damage to a structure a few thousand dollars doesn’t actually go very far.

“The insurance product here is really better for everyone involved in the transaction —  landlords are getting better protection compared to standard security deposits, while apartment seekers drastically reduce the high upfront costs of rentals,” Ben-Zvi said. “It is hard to imagine preferring having to hold cash in an escrow account for an open-ended period that may not even be sufficient to its task when is time to use it.”

Average rents rose 36 percent nationally over the past decade, though rents rose more than twice that amount in hot markets such as Denver and Seattle, according to Yardi Matrix. About a quarter of American renters pay 50 percent or more of their income in rent, according to listings platform Apartment List.

And yet, landlords are not universally enthralled with the idea of an insurance product in place of a large cash deposit, and not every landlord offers an alternative. But that, in some markets, might be changing, as legislators concerned about the continuing affordability crunch in their cities are looking at regulatory fixes to slow the pace of security deposit growth.

Mechanisms have varied by locality — some states and municipalities have looked at capping deposits while others have looked to limit the pace at which rents can grow. But in states like Virginia and cities like Cinicinati, legislation has recently passed that require landlords to accept alternative payments for security deposits like insurance products, according to reports.

“For a significant number of people living in Cincinnati, a security deposit for a two-bedroom would equal or exceed the totality of their savings,” Cincinnati City Councilman P.G. Sittenfeld, sponsor of Cincinnati’s new deposit law, told The Wall Street Journal. “To put down $1,000 up front, that’s a significant expense for some people.”

But landlords remain unconvinced, arguing against the alternative payments legislation in multiple localities that  is necessary to protect their assets and make sure a tenant doesn’t skip out without paying the last month’s rent. Landlords also say the insurance-based system creates new burdens for them. Where once they had the cash in hand to make any repairs necessary at the end of a lease, now they have to work to extract that money from the insurer.

“Now I’m in a whole different realm,” said Charles Tassell, chief operating officer of the National Real Estate Investors Association. “I’ve got to deal with an insurance claim and get my attorneys involved. And they’ve got their high-priced attorneys in-house.”

Consumer housing advocates counter that landlords are often concerned about screening out low-income potential tenants and use steep security deposits as a mechanism to do so, and that the burden ought be on them to prove their claims about damage, not on renters to disprove them in small claims court. But consumer advocates also note that the insurance program may not really be a silver-bullet solution here either, since a customer who would have collected their whole security deposit back is at a net loss with this platform.

Plus, depending on the configuration of the platform, in the case of damages that exceed the security deposit as estimated at the start of the lease, the consumer can still be on the hook for additional costs.

But, as Rhino’s Paraag Sarva observed, a solution is necessary here, as over $130 billion is locked up in security deposits, and an increasing number of consumers are locked out of expensive rental markets by them.

“We’re just starting to make a dent in turning that tide. I’d love to see that flip to where cash security deposits are the exception,” he said.