I recently wrote about Obligo, a startup that allows renters to pay a monthly fee instead of sending a security deposit to the landlord. This setup provides an alternative to surety bonds. And now deals like this aren’t just available in New York. The City of Los Angeles just changed its laws so that tenants can get their deposits back if they purchase insurance to protect their landlord from losses. Other major cities have already passed similar legislation.
Why Security Deposit Rules Changed
The idea is that the tenants will get their security deposits back and go out and spend the money. This spending will stimulate the economy without requiring either the city, the state, or the federal government to pay out additional stimulus funds. Unlike the previous stimulus checks sent out by the government, tenants will get their own money back this time. So I don’t consider this regulatory change the same thing as a stimulus.
Whether accepting the deal is worth it depends on the tenant’s current financial position. A tenant could treat the decision to withdraw and spend the rental deposit money like taking out a loan. If the returned security deposit prevents the tenant from getting evicted or allows them to avoid borrowing on a credit card or taking out a payday loan, the deal could be worth it. But withdrawing the money to go holiday shopping with it isn’t a good deal for the tenant, even if that’s what local officials want.
Financial Effects of Withdrawing Deposits
This reminds me of the asset-light approach that many corporate managers and private equity firms use to manage their businesses. And it also reminds me of concepts like sale-leaseback agreements. The insurance policy frees up capital that the tenant can use elsewhere. For example, the tenant could pay off high-interest credit card debt after getting the deposit back. Or the money could be spent on car repairs, work clothes, or other things that allow the tenant to earn more money.
Security deposit coverage costs about $5 per month to replace a thousand-dollar deposit, scaling up when the deposit is larger. That’s $60 per year to provide $1000 in value, so a policy like this can be treated like a loan at 6 percent. Low-income renters might normally have to borrow money at much higher rates than that, especially if they’re taking out unsecured loans.
Higher-income renters who have access to investments that generate higher returns may be able to earn more income with the deposit money they get back. They could borrow at 6 percent and earn 10 percent, for example. But the investment at 10 percent won’t be risk free. And renters who get their money back and don’t need to spend it on bills immediately may use it to trade options and tech company stocks on online brokerage apps like Robinhood. That already happened with the first round of stimulus checks.
Social Effects of Withdrawing Deposits
The rental deposit may be the only financial asset a tenant has. If the tenant withdraws it and spends it, this asset is replaced by another monthly bill. And tenants are aware of this. A rental deposit is also a less visible asset that creates forced savings. There’s no pressure to spend the money when it’s deposited at the landlord’s bank and the landlord controls it. But if that money’s sitting in the tenant’s bank account the tenant may face social pressure to spend it.
A setup like this could also trap tenants. They won’t get the deposit back when they move to their next apartment, so they’ll have to sign a new contract with another insurance company when they move. They might need to save up the deposit money after starting from zero again. And if they do save up money for another security deposit, this will have the opposite effect on the local economy as spending the deposit money would have. The decision would be better for the tenant, of course, but the local government might not like it.
Renters benefit by having the option to withdraw their deposits and spend them if necessary. But these withdrawals shouldn’t be viewed as a source of stimulus money. Tenants should think of these types of insurance policies as options to borrow cash at 6 percent. Taking out a loan like that might be worth it if it allows the renter to move into a big city where jobs pay much higher wages, or if it allows the renter to consolidate other debt. Otherwise, it might be a better choice to leave the deposit with the landlord.