Renting an apartment in New York City can be expensive, especially in neighborhoods such as Manhattan. A new tenant might need to come up with $3,000 for the first month’s rent, plus another $3,000 for a security deposit. And the broker’s fee could be another $3,000 on top of that. The tenant may need to have $9,000 in a bank account before even applying to rent an apartment. So Obligo came up with a solution that allows the tenant to avoid paying the security deposit up front.
The Reason for Security Deposits
Landlords ask for security deposits in case the renter damages the property. The landlord can use the security deposit to cover any repair fees, returning the rest of the money to the tenant at the end of the lease. The security deposit is often the same as one month’s rent. So if the apartment costs $3,000 a month to rent, the tenant writes out a check for $6,000 to the landlord in the first month. Then, when the tenant moves out later, the landlord sends the tenant another check for $3,000 minus the repair costs.
Surety Bonds as an Alternative
Insurance companies introduced surety bonds as an alternative for tenants who couldn’t pay the full security deposit up front. When an insurance company provides this service, it’s called a guarantor. And insurtechs like TheGuarantors and Jetty provide a modern version of guarantor services. The tenant pays a fee of around 17 percent of the first month’s rent to the insurance company in exchange for a surety bond. The guarantor service agrees to compensate the bondholder, the landlord, if the tenant damages the apartment. With this service, a tenant would only have to pay $510 for a surety bond instead of giving a $3,000 deposit to the landlord.
Drawbacks of Surety Bonds
Obligo points out several drawbacks of surety bonds on its blog. The main one is that they create a market for lemons. Tenants who are likely to damage the apartment will benefit the most from surety bonds. They have to pay a smaller amount to the insurance company up front to convince the landlord to rent to them. But for a good tenant, a surety bond is a bad deal. Instead of getting the security deposit back later, the tenant loses the entire value of the surety deposit immediately. Landlords may not want to rent to tenants who offer them surety bonds.
Surety bonds differ from insurance policies. If a landlord makes a claim against the surety bond, the insurance company will pay off the claim and then attempt to collect the claim money from the tenant. So it’s not as difficult for the landlord to convince the insurance company to pay for damages as it would be if the landlord took out a traditional insurance policy and submitted a claim. The landlord still has to rely on the insurance company to have cash available to pay off the surety bond claim, though.
An Alternative Guarantee
Hotels also rent rooms to guests, but they don’t ask for security deposits. Instead, they ask for the guest’s credit card and put a hold on it. And gas stations often place a hold on a customer’s credit card before they know the final fuel bill. So Obligo decided to provide a similar service with apartment leases. Its guarantee service is similar to the authorization to make credit card charges that guests provide to hotels, or the authorization you give to a gas station when you swipe your credit card.
It would be a big deal for a landlord to place a $3,000 hold on a credit card, or even a $1,000 hold in a neighborhood where rents are lower. So Obligo isn’t doing that. It asks its users for a billing authorization, along with their credit card and bank account details. If the tenant damages the property, Obligo deducts the repair costs directly from the tenant’s accounts. In exchange for this service, Obligo guarantees that it will reimburse the landlord for property damages. And the tenant pays a variable fee of about 0.4 percent per month for this service, or $12 per month on a $3000 apartment rental.
Tougher Market Conditions
Rent prices are falling in New York and the market is becoming more competitive for landlords. Tenants are receiving concessions that make their effective rent prices lower. For example, a landlord might offer the tenant a free month of rent. So even if the sticker price is still $3,500 per month, the effective rate might be $3,100 a month or less. One way for a landlord to offer a concession, or a subsidy, to a new tenant is by covering the cost of a service like Obligo for them. By providing this subsidy, the landlord can also attract tenants who were turned down by other property managers. Obligo does perform some credit checking services itself so it doesn’t lose money on its guarantees, which might make the landlord more confident about accepting these tenants.
This rent guarantee service would be very useful for tenants who can’t pay the security deposit up front, but don’t want to lose money by purchasing a nonrefundable surety bond either. And it could be very useful for low-income renters during the pandemic, especially if a renter needs to move to a new apartment. Coming up with the cash for a security deposit could be very difficult at a time when many businesses are still operating at limited capacity.