An essential part of the real estate lending process for both property owners and tenants is providing an appropriate security instrument. It serves as a guarantee for the landlord that the property will be kept in good shape, expenses incurred would be paid, and any damages caused would be covered at the end of a rental period. In addition, the security instrument functions as a motivation for renters to take care of a property and pay outstanding rent and bills in time to avoid financial penalty.
The traditional method for owners to ensure that their rights will be safeguarded is to require a security deposit. It is the most widely spread tool, which entails that tenants have to pay the deposit amount in full upfront when signing a lease.
Another security instrument that is preferred both by landlords and renters is the surety bond. It provides protection for the owner against a tenant’s non-compliance with the rental agreement. However, it functions in a slightly different way than a deposit and may be more appropriate for some leasing cases.
Here is what you should know about using a surety bond vs security deposit for your next real estate rental contract.
How does each security instrument work?
In the case of using a traditional security deposit, the process is well-known. The landlord sets an amount that the tenant has to provide when renting the property. Typically, the amount is between one and three monthly rental fees. It should be paid in full. Any proven damages caused will be deducted from the deposit. The owner has to return the remaining amount at the end of the rental period. In addition, in most states, there are requirements about the way the deposit is kept. Often it should be in a separate bank account apart from other finances. In some places, it should even be placed in an interest-bearing trust account and the interest has to be directed to the tenant at the end of the lease.
If the parties decide to use a surety bond instead, the process is slightly different. The bond represents a contract between the landlord as the obligee, the renter as the principal, and a surety provider. With the bonding, the surety guarantees to the property owner that the tenant will follow his rental contract obligations.
While the safety ensured is equal for both instruments, the parties to each rental lease may have preferences to which option works best for their specific circumstances.
What are the costs for surety bonds vs security deposits?
The costs involved with the two security instruments diverge. If obtaining a security deposit, a tenant has to provide the whole amount that the landlord has set. Thus, if the property owner demands a $5,000 security amount, the renter has to pay the sum at the time of signing the lease. The money stays with the landlord for the duration of the contract and has to be returned partially or in full at the end.
If the preferred security method is a surety bond, the costs are different. The tenant has to cover a fraction of the security amount, which is referred to as the bond premium. It is determined on the basis of the strength of the renter’s finances. The common factors that a surety would consider involve personal credit score and finances, or business financials if relevant, as well as additional assets and liquidity, showcased. Typically, the rates are between 1% and 5%, with a minimum bonding premium of $100. Thus, the premium that has to be covered may be as low as $100 to $250 for a $5,000 surety bond. While the costs are lower for the tenant, the coverage for the property owner is in full. The difference with a deposit is that the bond premium is not refundable.
How does financial compensation work in both options?
The way a landlord can obtain rightful compensation for damages or other violations of a rental lease is different for surety bonds and for security deposits. However, both instruments provide a high level of security for the owners.
In the case of a deposit, the property owner keeps the required sum for the duration of the contract. If at any point they establish non-compliance of the tenant, they can block an appropriate amount to serve as reimbursement. Thus, at the end of the lease, the renter may receive only a partial or none refund of the security deposit. In this way, the owner protects his property and ensures a tenant would not leave without paying outstanding costs. In the case of blocking compensation, the landlord has to provide an itemized list of damages. They also have to return any outstanding amount to the renter within a legally fixed timeframe.
When a surety bond is used as a security instrument and there is a violation of the rental lease, the owner has to file a claim against the bond. The surety that has provided the bonding assesses the situation to confirm the validity of the case. This ensures that landlords would not misuse the compensation option for unreasonable claims. On proven cases, however, the tenant has to cover the reimbursement costs. The owner can demand a sum that is as large as the bond provided, and the renter is obliged to pay it. To ensure fast reimbursement, the surety may cover the costs initially. However, the bonded party, i.e. the renter, needs to quickly repay it, as this is set in the bond indemnity agreement. Thus, a tenant cannot evade the payment of damages.