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What are the risks of ‘do-it-yourself’ deposit replacement schemes?

Deposit replacement schemes were born out of renters’ need for flexibility and as an alternative to the traditional deposit model, which relies on often substantial upfront costs.


Research by traditional deposit schemes show that the average rental deposit in England and Wales in 2020 is £1,139, albeit slightly lower in areas outside London and the South East. In many cases, tenants will be expected to pay a deposit for their new rental home before having their deposit from their old property returned, a scenario also known as a deposit ‘double bubble’.


Due to the cash flow issues that are currently facing many tenants - exacerbated by the coronavirus crisis - deposit replacement schemes have grown in popularity.


But despite their increasing popularity, there is significant debate surrounding deposit replacement schemes. Concerns have been raised by many in the industry, with some tenants claiming that they were mis-sold schemes without being made aware of the non-refundable nature of their payments.


What are deposit replacement schemes?

Deposit replacement schemes should offer tenants choice, flexibility and transparency. Deposit replacements come in a variety of models; however, the common theme is that they replace the tenant’s need to provide a one-off lump sum deposit with a deposit replacement product, whereby the tenant pays by a non-refundable fee.


The schemes guarantee the same financial protection to the landlord as a traditional deposit; paying the landlord any monies due if the tenant won’t and chasing the tenant for the outlay the scheme has had to make. Some schemes operate a pure insurance model whilst others offer a membership style approach, in which the scheme insures itself against any liabilities it has to pay.


Deposit replacement schemes remove landlords’ need to register the deposit and therefore remove the risk of fines for failing to protect that deposit.


However, some landlords might be wary of these schemes for fear that the lack of a traditional cash deposit encourages more cavalier behaviour by the tenant in terms of honouring their obligations within the tenancy agreement, and are therefore higher risk.


The Tenant Fees Act made it illegal to charge tenants fees except for deposits and rents. Therefore it is only legal to offer a deposit replacement option alongside a traditional deposit. Landlords and agents cannot insist on a tenant opting for a deposit replacement if they would rather choose a traditional deposit.


Tenants may elect for a deposit replacement scheme over a traditional deposit for a number of reasons. For some renters, the flexibility of deposit replacement schemes may help to support positive cash flow in an ever-changing financial landscape. Deposit replacement schemes also deal effectively with the deposit ‘double bubble’ as physical money is not tied up in a custodial tenancy deposit scheme or held by the landlord or agent. These two benefits alone will no doubt form the basis of the future ‘Boris Lifetime Deposit’.


Deposit replacements have slowly started to gain traction over the last few years, with well-known industry names joining several start-ups in the growing niche market. This competition has increased the transparency and expectations of customer service. However, there have also been several ‘in-house’ deposit replacements developed by large letting agencies, which has led to some concern over their independence and motivations.


Risks of ‘do-it-yourself’ replacement options

A ‘do-it yourself’ deposit replacement scheme is a deposit replacement option offered and operated by the agents themselves. Recently, The Times shared a story of a tenant who was shocked by the final bill she received after opting for a deposit replacement scheme run by an agency. However, the issue of mis-selling “deposit-free” renting is not new.


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.


Volunteer campaign group Generation Rent has also warned against certain “deposit-free” products, calling them "definitely not free and less protection for renters."


The group highlights that, unlike traditional deposit schemes, deposit replacement schemes are not licensed by the Government and are therefore open to possible abuse.


Similarly, in some cases, rather than utilising independent deposit replacement schemes, some agents have been known to offer their tenants a ‘do-it-yourself’ version and have mis-sold deposit replacement products, pressuring tenants into taking a ‘deposit-free’ option over a traditional lump sum deposit or charging tenants additional fees to raise a dispute to dissuade tenants from raising a dispute. Some agents push their own ‘do-it-yourself’ model to fill the black hole left by the tenant fee ban often failing to operate transparently with renters.


It is far safer for landlords and their tenants to opt for independent and established deposit replacement schemes that fully explain how the scheme works.


There is no inherent problem with deposit replacement schemes when designed correctly, transparently, and with landlords and tenants in mind. They offer another option to tenants who may seek a new route into renting or to support their changing financial requirements.


Commenting on the issue, Sean Hooker, Head of Redress at The Property Redress Scheme said:


“At the Property Redress Scheme, we have unfortunately witnessed many cases of landlords and tenants being mis-sold products within the private rented sector. It is therefore incredibly important that any tenant or landlord signing up for a deposit replacement scheme does their research to ensure that there are no hidden costs, clauses or surprises in store further down the line. These alternatives only work successfully if all parties understand the purpose and workings of the scheme.


Agents should make sure that tenants are fully informed of all the pros and cons of both traditional deposits and alternative deposit replacement schemes before asking their tenants and landlords to decide what option works best for them. This will ensure that they are fully aware of any potential costs that could crop up at a later stage.


For this very reason, our parent company, Hamilton Fraser, has launched its own deposit replacement provider, Ome. Ome aims to support the ever-evolving housing market and define the new standards expected from a deposit replacement scheme, focusing on choice, transparency and flexibility. Operating in the private rented sector for over 25 years, Hamilton Fraser is well placed to support the sector with existing industry and deposit knowledge and established infrastructure.”


Benefits of independent deposit replacement schemes

Deposit replacement schemes can offer tenants new levels of choice throughout their rental journey and there are many benefits for agents too.


Deposit replacement options offer the same financial protection as traditional deposit schemes, whilst minimising legislative risk to agents and landlords and reducing the threat of deposit protection related fines, which come with non-compliance.


In addition, with a deposit replacement scheme both parties save time and energy through the removal of cash deposit admin.


Launched earlier this year, Ome, member of the Hamilton Fraser family and partner of mydeposits, is a deposit replacement scheme which offers a free adjudication service, just like traditional deposit schemes. The wealth of knowledge gathered from the years of successfully operating mydeposits, a government authorised deposit scheme, has provided significant insights into the changing needs of landlords, agents and their tenants, and how they can be best supported.


Ome’s promise is “… to provide a supportive solution for those seeking a replacement to a traditional cash deposit that can adapt to tenants’ individual circumstances” and to diversify the rental market with its unique transparency.


It is important that agents only offer deposit replacement schemes to tenants who are fully aware of the pros and cons of this option, and what they are signing up for.


Co-founder of Ome, Matthew Hooker, commented:  “The rental market is ever-changing, and deposit replacement schemes offer a viable alternative for many modern renters looking for a substitute solution to the traditional deposit.


It is unfortunate that some renters feel they were mis-sold deposit replacement schemes, and the Hamilton Fraser group is well aware of the pitfalls surrounding these alternatives. We felt that the best way to tackle these issues was to launch Ome, in order to offer renewed choice to the lettings market, whilst maintaining the rental wellbeing of tenants, landlords and agents.”


The positives and negatives of deposit replacement schemes have been well-documented and discussed within the industry. But unfortunately, there are still cases where agents have pushed their tenants towards deposit replacement schemes without ensuring they fully understand how they work.


Despite these negative cases, when properly explained and transparent, for many tenants deposit replacement schemes are a viable and supportive rental option, providing them with increased flexibility and, most importantly, choice. Therefore, as long as all parties have researched and understood how the schemes work, deposit replacement schemes can offer a competitive and progressive option within the UK rental market.


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Property Redress Scheme is approved by Government under the Alternative Dispute Resolution for Consumer Disputes (Competent Authorities and Information) Regulations 2015