Tenancy deposits are a minefield if you are not a professional landlord or letting agent, or if you are new to renting out residential properties. In this blog I will explain the importance of taking a deposit (despite what some ‘old school’ landlords often say!) as well as distinguish between the different deposit protection schemes, and the pros and cons of each.
Firstly, I would always recommend taking a security deposit from a tenant. The whole point is that it gives you some fall back/security if the tenant falls into arrears or breaches the tenancy by damaging the property or not returning it in the condition required under the tenancy agreement. However, legally as it stands, you can only take a maximum deposit equivalent to 5 weeks’ rent (monthly rent x 12, divided by 52 and then x 5). You cannot charge a pet deposit or any other extra deposit.
I have previously rented properties and rooms to tenants without a deposit (and taken a guarantor instead, or used a Zero Deposit scheme), however when tenants provide a deposit they have ‘skin in the game’ at the end of the tenancy, which means that they are incentivised to return the property in a good condition to obtain their deposit back. Tenants who do not provide a deposit often think and behave in a manner which implies that they do not have any money to lose if they do not return the property in a clean condition in accordance with the tenancy agreement, and it’s more difficult to claim the money back from the guarantor or Zero Deposit scheme (than it is if there were a deposit in place).
However, taking a deposit is only one part of the equation. You also need to have a comprehensive and robust inventory at the start of the tenancy, and you need to complete a full check-out inspection report at the end of the tenancy. That will give you the best chance of making a successful claim on the deposit if the tenant disputes your proposed deductions or disputes that they did not return the property in accordance with the tenancy agreement.
So once you have taken a deposit, what is the legal position?
In the UK, landlords are required by law to protect their tenants' deposits using one of the three government-approved tenancy deposit schemes. At the moment, these are (a) Tenancy Deposit Scheme (TDS), (b) Deposit Protection Service (DPS) and (c) MyDeposits. These schemes ensure that tenants can get their deposits back if they meet the terms of their tenancy agreement and don't leave with rent arrears or damage the property.
Within the schemes, there are two main types of deposit protection: custodial and insured. Let's explore the differences, as well as the pros and cons of each.
Custodial Deposit Schemes
In a custodial scheme, the landlord or letting agent is required to transfer the tenant's deposit to the scheme (TDS/DPS/MyDeposits). Once the scheme has received the tenant’s deposit, then the deposit is ‘protected’. The deposit scheme then holds the money for the duration of the tenancy. The landlord/agent must serve the deposit certificate, as well as the prescribed information relating to the deposit, to the tenant within 30 days of receiving the deposit. Failure to do this can lead to financial penalties (up to 3 times the deposit could be awarded to the tenant) as well as preventing the landlord/agent evicting a tenant using the section 21 process. Therefore it is vital that these formalities are completed on time.
Each party (landlord/agent and tenant) has their own online account within the scheme, so that they can see that the deposit is protected. At the end of the tenancy, the landlord/agent and tenant must come to an agreement regarding any deductions from the deposit. If they do not reach an agreement, then the landlord/agent must make a claim on the deposit through the custodial scheme. The landlord/agent would need to provide the details of any rent arrears/breach of tenancy, and the cost of any remedial works, to the custodial scheme, by way of photos/reports and invoices or quotes from contractors. The scheme would settle the dispute through its dispute resolution process. This can unfortunately take months to settle, as the scheme gives each party time to put forward their evidence and then takes time to determine the dispute.
Advantages of the custodial scheme:
1. It is free for landlords/agents and tenants
2. The deposit is securely held by a third party (so the tenants do not need to fear if the landlord/agent goes bust or runs off into the distance)
3. There is an impartial dispute resolution service in the event of a dispute at the end of the tenancy
Disadvantages of the custodial scheme:
1. The landlord doesn't have access to the deposit funds during the tenancy
2. It may take longer to return the deposit to the tenant at the end of the tenancy, especially if there is a dispute
3. It requires more administrative work for landlords/agents at the end of the tenancy, especially where there is a dispute on the deductions from the deposit
Insured Deposit Schemes
If the deposit is registered and protected in an insured scheme, the landlord or agent keeps the deposit in their own bank account, but pays a fee to insure it. The deposit scheme guarantees to return the deposit to the tenant if the landlord or agent fails to do so. Therefore, the tenant still has a way to recover the deposit in the event that the landlord/agent goes bust or runs off with the money. Like with the custodial scheme, the landlord/agent must serve the deposit certificate, as well as the prescribed information relating to the deposit, to the tenant within 30 days of receiving the deposit. The same financial penalties and inability to evict under a section 21 notice would also apply, as described above under the custodial scheme.
At the end of the tenancy, the landlord/agent would propose any deductions from the deposit to the tenant. However, if the tenant disputes any of these deductions, the tenant must make a claim to the insured scheme and put forward their evidence of why the landlord/agent should not be deducting from the deposit. This is a significant difference as it puts the onus on the tenant to make the claim. Again, the insured scheme can determine any disputes through its dispute resolution process, but in reality it is much quicker and easier for the tenant to agree to the landlord/agent’s deductions to receive the remainder of their deposit back than to go through the lengthy process of dispute resolution within the insured scheme.
Advantages of the insured scheme:
1. The landlord/agent retains control of the deposit funds
2. It is generally quicker to return the deposit to the tenant at the end of the tenancy, assuming there are no deductions from the deposit (or the tenant agrees to the landlord/agent’s deductions from the deposit)
3. There is less administrative work for landlords/agents at the end of the tenancy, as it becomes the tenant’s responsibility to make a claim if they do not accept the landlord/agent’s deductions from the deposit
4. The landlord/agent can earn interest on the deposit during the tenancy (rather than the deposit scheme earning interest!). This can be significant for landlords/agents who hold multiple deposits.
Disadvantages of the insured scheme:
1. The landlord/agent must pay a fee to insure the deposit
2. There is a higher risk of a landlord/agent misusing the deposit e.g. spending it and then not having the funds at the end of the tenancy to return back to the tenant (although as it is “insured”, the tenant can still claim it back from the deposit scheme)
My experience
As an experienced landlord and agent, I have used both insured schemes and custodial schemes to protect tenants’ deposits over the years. When I started my business, I was drawn to the custodial schemes due to the fact that they were free. I also had fairly good relationships with my tenants and found that they were reasonable (and I should add, so was I) at the end of the tenancy when agreeing to deposit deductions. I would not make excessive deductions if the property had been returned in a fairly decent condition, and in some instances I even returned deposits to tenants in full without any deductions at all (if the tenant returned the property in a great condition, or if the tenant had been in the property for a long period and had otherwise been a great tenant). As a landlord, I understand that if a tenant has been living in a property for 3/4/5 years or more, than there is bound to be some wear and tear and even some cleaning costs at the end of the tenancy, and if they were fairly minor and the tenant had otherwise been paying on time and did not cause me any hassle during the tenancy, then I would return the deposit in full. It was an informal ‘quid pro quo’ arrangement which worked fairly well.
Up until recently I would have continued using the custodial scheme, however in the last 12-18 months I have noticed a change in attitude/behaviour from tenants when it comes to the end of the tenancy. Sadly more and more tenants feel that they are owed the deposit back in full, even when they have not returned the property back in a clean condition or have left with rent arrears or other breaches of tenancy. I have had tenants who have been particularly difficult and refused to accept any reasonable deductions, even when they have left owing £thousands in rent arrears(!), and some have simply failed to co-operate with the deposit claim process, especially where they leave the property with arrears and damages which exceed the deposit amount. In my experience there is no incentive for tenants to be reasonable when it comes to agreeing deposit deductions, because they effectively have a ‘free hit’ in disputing it, especially when the deposit is in the custodial scheme. The onus is then on the landlord/agent to prove that the deductions are valid and it can take months for the scheme to determine the dispute. This is not only an administrative chore for landlords/agents, but it also means that landlords/agents have to deal with the cashflow issue of paying for repairs/maintenance out of their own pocket (which would have been taken from the deposit) until the time when the deposit scheme determines the dispute.
As a result of my recent experiences, whereby I have gone through the hassle and pain of dealing with ‘have a go’ tenants or unresponsive tenants who end up forcing me to go through the dispute resolution process to claim the deposit, I have now decided to protect tenants’ deposits in the MyDeposits insured scheme. Time will tell whether this decision pays off in terms of fewer disputes and quicker settlement, but at least I know that I am holding the deposit in my account and if the tenant acts fairly and reasonably then I will happily fulfil my obligation to quickly return the deposit to them (less any fair and reasonably deductions as the case may be). And if I do encounter difficult tenants who dispute the deductions (even when they trash the house or leave owing £thousands in rent arrears – yes this has actually happened…), then it is up to them to make the claim to prove their argument.
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