The start of a tenancy can be emotionally and financially draining. After the stress of ensuring your finances are in order and packing your life up into boxes, avoiding any additional trouble is every tenant’s dream. Part of the nightmare can be scrambling to pay the looming deposit fee before moving in. According to the Deposit Protection Service, the average deposit for London renters costs £1,750 – a significant upfront investment. However, new deposit replacement services are providing an intriguing alternative to traditional tenancy deposits, allowing tenants to reduce the size of their upfront costs.

Deposit replacement schemes are a relatively new development in the lettings industry, increasing in popularity due to their versatile financial structure and the accessibility of their user-friendly proptech software and apps. Zero deposit providers reduce upfront costs for tenants through charging lower, non-refundable fees to tenants for insuring the landlord against property damage. However, deposit replacement schemes remain new and relatively untested and, in many cases, they also end up costings renters significantly more overall than a traditional deposit. Many renters and landlords therefore proceed with caution before choosing to forgo a conventional tenancy deposit.

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What is a deposit replacement scheme?

Rather than paying a large deposit upfront, deposit replacement schemes offer tenants the opportunity to pay a smaller, non-refundable fee before starting a new tenancy. Traditional deposits require tenants to make a refundable payment of five or six weeks’ rent prior to moving into a property, whereas deposit replacement schemes typically cost the equivalent one week’s rent or are paid in monthly installments. In exchange for the tenant’s fees, the provider offers the landlord protection that is equivalent to or greater than a standard deposit, should the renters incur any costs.

This new alternative arrangement provides flexibility for tenants who would struggle to find 5 or 6 weeks’ rent for a deposit in addition to all the costs associated with moving. Others also choose to opt for a deposit replacement solution as a lifestyle choice, preferring to lose some money in non-refundable fees to keep the larger lump sum of their savings available for spending on leisure (e.g. a holiday).

How do deposit replacement schemes work?

Deposit replacement schemes are taken out by a letting agent or a tenant through a third party agency, before tenancy takes place. They are are offered as an optional alternative to traditional deposits and a tenancy cannot be conditional on the renter agreeing to a zero deposit arrangement. Landlords must opt into the deposit replacement scheme for tenants to partake in it, so it is therefore not offered as standard across all listings. Nevertheless, if all parties are happy to proceed, deposit replacement schemes remove a landlord’s obligation to register a deposit in a government-approved tenancy deposit scheme.

As for how they work, the technicalities vary by provider. Some firms require tenants to pay non-refundable low-cost monthly payments whereas others allow tenants to pay a single non-refundable upfront fee. For long-term tenancies, certain schemes may offer the option to pay a yearly renewal fee as well. Regardless of payment schedule, these policies serve the same purpose as traditional deposits. A tenant’s payments are used to cover the cost of any potential damages or rent arrears, or other violations of the tenancy agreement.

Who offers a deposit replacement scheme?

Due to their increasing popularity, deposit replacement schemes are now being offered by proptech start-ups and well-known industry players alike. Certain agents also offer and operate their own deposit replacement schemes. However, some agents may offer “do-it-yourself” replacement schemes, which can misconstrue the requirements of the scheme. The Property Redress Scheme has the following to say about DIY zero deposit services:

‘Back in February 2020 the BBC highlighted the plight of tenants who signed up to deposit-free options from agencies, but were unaware that the money paid into the scheme would be non-refundable and could not be used to pay for any damages.

Whilst transparency over a tenant’s obligations is important regardless of the deposit replacement scheme used, it can be particularly problematic with agency operated schemes which charge tenants significantly more than specialist deposit replacement schemes.

The BBC found that some tenants were encouraged to opt for deposit replacement schemes rather than traditional deposit schemes without fully understanding the ramifications of their decision.’

Landlords and tenants are far safer using a zero deposit alternative with an agent if they use an independent, established deposit replacement provider, who offer clear terms of business and a transparent explanation of how the scheme works.

What are the benefits for landlords?

Deposit replacement schemes can potentially provide a greater safety net for landlords dealing with unpaid rent or dilapidations, compared to traditional deposits that are limited in coverage due to the Tenant Fees Act. Agencies providing deposit replacement schemes also usually provide adjudication services for any potential tenant disputes.

Moreover, as deposit replacement arrangements do not have to be registered with one of the government-approved deposit protection schemes, landlords who agree to the alternative service have fewer administrative responsibilities. Failure to timely register a deposit or incorrectly registering one can result in a myriad of fines; deposit replacement schemes take away that worry by avoiding the process altogether. Additionally, the lower financial barrier for tenancy can attract more prospective tenants, making the letting process quicker and easier.

What are the benefits for tenants?

Deposit replacement schemes can alleviate the financial burden of traditional deposits through manageable monthly payments or a reduced cost at the start of tenancy. Tenants may be less likely to take out a loan to cover upfront costs or save up months in advance to qualify for the unit they are interested in. Deposit replacement schemes can also provide greater financial freedom when tenants move out of a property. Rather than paying another deposit at their new property while waiting for the old unit’s deposit to be given back, tenants can avoid the so-called “double bubble” and confidently move on without time lost.

What are the concerns for landlords?

Because tenants are less financially tied to the property, some landlords worry tenants will be less incentivized to maintain the property’s good conditions. There is little evidence to support this claim; tenants are still investing money into the property and know that avoiding payments will put them at risk with the landlord and deposit agency. For situations where such issues may arise, agencies provide tenant dispute resolution services.

What are the concerns for tenants?

As opposed to traditional deposits, where tenants are likely to get their deposit back, deposit replacement schemes are non-refundable. The cost of paying a smaller fee upfront results in the lack of repayment at the end of tenancy. Lack of transparency in certain schemes can also confuse tenants on what their insurance actually covers. They may not realize that landlord claims will result in the policy pursuing them for the outstanding costs.

Additionally, many providers do not disclose what interest tenants may be charged with on repayment settlements. Any lack of financial transparency should be noted by tenants before signing a contract, to avoid surprising additional costs. Certain providers may also require access to a tenant’s bank account through open banking, and many renters are understandably uncomfortable with the idea of withdrawals being made directly by a third party.

How are deposit replacement schemes regulated?

All insurance products offered by agents must abide by the Financial Conduct Authority (FCA) regulations regarding financial product promotion. Insurance products cannot be sold or advised by agents who are not authorized by the FCA. However, an agent’s FCA authorization does not guarantee the service’s authorization. Additionally, if a scheme is classified as a contract of insurance, it falls under the protection of the Financial Services Compensation Scheme, providing a safety net for consumers in case a provider fails.

Is there high demand for deposit replacement schemes?

Deposit replacement schemes have been increasing in popularity in recent years. While traditional deposits are still a preferred by most tenants and landlords, the alternative deposit insurance is increasingly attractive. Popularity of replacement schemes vary by demographic, piquing the most interest among younger renters hoping to relieve some financial pressure upon move-in.

It’s ultimately a matter of personal preference. For tenants, deposit replacement schemes can provide desperately needed financial relief, as well as speeding up the turnover between tenancies. For landlords, a similar safety net is cast as compared to traditional deposits, in addition to lower chance of tenancy void periods due to easier accessibility.

Deposit replacement schemes offer flexibility for both parties. However, if you are looking into this alternative service, make sure to look into an agency’s certification and terms of business to ensure you are adequately protected, and know how much you’re going to be paying, before signing any contracts.

Author: Julia Kaluta

At Home Made, we offer a hybrid lettings solution that adds value at every stage of the rental process. With our game-changing new landlord platform, The Property Wallet, we offer London landlords exceptional tenant-find and property management services for a low monthly fee.

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If you would like to speak with us about your property needs, contact us via our website to find out how we can help. If you’re ready to get started, book your free valuation here.

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