The average 10% deposit on a down payment can be beyond the means of some home buyers, leading to a missed opportunity to buy their dream home. This does not mean, however, that a lack of ready access to cash completely prevents you from placing a deposit. In fact, a deposit bond, if used appropriately, can be a suitable alternative to a cash deposit.
This guide outlines some advantages, drawbacks and critical points to consider when considering a deposit bond during a property purchase. This will help ensure you don't put yourself at unacceptably high risk when buying property.
What Is A Deposit Bond?
When buying a property, buyers typically have to put down a cash deposit. On average, this is usually up to 10% of the purchase price. This serves as a guarantee of the buyer's commitment to the contract of sale.
Deposit bonds are a type of financial arrangement that may be used instead of a deposit, usually occurring when a buyer and seller exchanges contracts on a property during the sale process. This assures the seller that the buyer will pay the entire deposit on a specific date.
When taking out the bond, you'll have to pay the money, including other related fees, by an agreed date to the bond issuer, not the property vendor. On certain loans, issuers also provide lender-issued deposit bonds. This only happens if the borrower takes a loan from them.
If everything goes to plan, the bond is surrendered at settlement, and the property's purchase price is typically paid in full at settlement. On the other hand, if the buyer fails to close the purchase at settlement, the vendor claims the deposit guarantee from the bond provider.
Deposit bonds are issued mainly by insurance firms, although banks and other financial organisations can offer them.
The Pros of Deposit Bonds
Deposit bonds offer the purchaser many advantages, often enabling quicker transactions, cost savings, and greater financial liberty whenever it is time to make a purchase. The chief benefits include the following:
- No need for ready cash: Deposit bonds help you avoid dipping into your savings to access the cash required if you don't have liquid funds. For example, when your savings are held in equity, and you're looking for a simultaneous settlement; i.e. you’ve sold your existing property, yet funds aren't available to pay the deposit for the new home. Likewise, the deposit bond is a suitable alternative that helps avoid penalties, additional costs and other upfront costs when you break your fixed-term investment or sell shares.
- More affordable: Deposit bonds are cheaper than other borrowing options, such as bridging finance. You'll likely only have to pay a small one-off fee to the issuer of the bond. This is negligible compared to recurring interest payments on a loan.
- Convenience: To apply for a deposit bond, you must sign an application form and submit the required documents. If everything is in order, your application is approved within 24 hours, sometimes as little as 3 hours.
- Flexibility: Based on settlement time. If it occurs between 6-48 months you can choose between short-term or long-term deposit bonds. You can even use deposit bonds to purchase off-the-plan properties, under land or construction, along with an extended settlement.
- Suitable for auction properties: You can leverage deposit bonds when bidding at auction, also known as auction bonds, without stressing if there's a cash deposit required. If you have bid unsuccessfully at the first auction, you can reuse the bond at other auctions. In addition, if you return the unused bonds within 30 days of being issued, you may be eligible for a refund.
- Checks and safeguards: Like home loans, deposit bonds are considered a form of credit. They are covered by the National Consumer Credit Protection Act, which also includes the National Credit Code (NCC).
Cons of Deposit Bonds
There is always a downside to seeking out alternate means of payment, and deposit bonds have these specific issues:
- Early Release: Vendors that seek an early deposit release so they may make a cash deposit on another item can be apprehensive about taking a deposit bond;
- Selective Appeal: If the agreement insists on cash deposits, a buyer employing a deposit bond may find themselves in trouble. The buyer may incur extra costs due to a breach of contract terms. Likewise, the cash deposit is generally used to pay the commission due to a real estate agent. So in some cases, the real estate agents may reject it as they want to get their payment as early as possible.
- Financial Position Checks: You will need to go through stringent financial checks. This helps the bond provide to ensure that you'll be able to meet all your repayment obligations, including paying off the cash deposit, the purchase price and other related costs with buying a property.
- Fees and Upfront Costs: When using a deposit bond, you will have to pay fees and upfront costs in addition to the amount covered by the deposit. So, at the outset, check how much a deposit bond will cost before signing the dotted line. If needed, seek professional advice.
Deposit Bond Vs Bank Guarantee
Bank guarantees and deposit bonds are forms of insurance. They indicate the lending institution will meet the buyer's liabilities if the buyer cannot settle the debt. Nonetheless, they differ in certain aspects.
This quick comparison will help you understand the critical differences between a Deposit Bond and a Bank Guarantee.
- Meaning: A bank guarantee is an unconditional undertaking offered by the bank, on behalf of their customer, to pay the recipient of the guarantee the assured amount on written demand. On the other hand, a deposit bond allows buyers, like those in a property sale, to pay a deposit without accessing cash from their bank accounts. This is typically up to 10% of the purchase price and no money transfer takes place until the settlement.
- Security: Bank guarantees typically require some form of security. This could be cash security held with the bank on deposit or a specific type and value of real estate agreeable to the bank. For deposit bonds, buyers are not required to offer any security to the financial institutions issuing the deposit guarantee.
- Paperwork: Moreover, when home buyers apply for a bank guarantee, banks have to undertake a due diligence and liability assessment on the buyers. In simple words, bank guarantees have more paperwork and higher set-up fees, including ongoing costs, than a one-off deposit bond fee.
How Much Does A Deposit Bond Cost?
Deposit bond fees vary depending on the bond provider. The deposit bond amount, the house purchase price, and whether you have a pre-approval loan will determine the entire cost of the deposit bond.
Going by industry averages, for a short-term deposit bond, i.e., less than 6 months, you should anticipate paying 1.2% to 1.5% of the full purchase price. Long-term bonds valid from 6-48 months are considered case-by-case.
To explain, for a $400,000 purchase, where settlement is less than 6 months, you'll have to provide a 10% deposit of $40,000. Your deposit bond premium works to $5200 (i.e., $40,000 x 1.3%).
In comparison, short-term loans are costlier, usually ranging between 8-13%.
Nonetheless, before purchasing a deposit bond, it would be a good idea to check the cost of the available choices. It's also advisable to confirm in advance if the deposit bond fee is partially or fully refundable in case the purchase falls through.
How Do Deposit Bonds Work?
For starters, if you're a home buyer, you must apply for a deposit bond with a provider. Usually, the bond issuer will seek details about your financial position, purchase contract terms, and check your credit history. The aim is to ensure you have sufficient funds, for example, the First Home Owner's Grant (FHOG), to complete the purchase at settlement.
If the bank has referred you, the issuer may use the information provided by the bank. Once your application is approved, a bond guaranteeing the deposit amount will be provided to your seller or the seller’s solicitor.
They will retain the bond until settlement time and claim the deposit bond only if you do not pay the deposit by the time of settlement.
What Documents Do I Need?
Even though each circumstance is unique, some standard supporting documentation is required.
You will most likely have to provide your recent bank statements and evidence of the availability of funds like your fixed-term deposits, savings and share certificates. Likewise, if you're accessing the First Home Owners Grant, you must submit related proof.
In addition to this standard requirement, the documents required depend on the following circumstances:
Formal Approval is Received or Settlement Within 6 Months:
- Photo IDs of all applicants
- Contract of sale for your purchase property
- Contract of sale for the selling property if settlement is simultaneous
- Bank or lenders letter confirming finance approval
For Off-the-Plan Purchase/Purchase through Company or Self-Managed Super Fund (SMSF)/ Settlement in More Than 6 Months:
- Photo ID of all applicants
- Contract of sale for the purchase property
- Payslips and/or tax returns of the past two years
- Rates notices of properties owned
- Rental statements of investment properties if you have been renting out
What Is the Time Frame for Obtaining a Deposit Bond?
The timeframe for obtaining a deposit bond varies across providers. Nevertheless, once you submit the required paperwork, pre-approval could likely take a few minutes to a couple of hours.
In most cases, once you've signed the contract, the deposit bond will be dispatched immediately within one business day to all relevant parties. This includes the real estate agent, mortgage broker, purchaser and vendor's legal representative.
Are Deposit Bonds Risky?
A deposit bond is more like an insurance policy. However, it is not recognised as a true deposit and can cause both parties significant trouble when unexpectedly used. For example, where a contract states that a deposit is to be paid and/or where the seller relies on the deposit money to fund a purchase.
Moreover, suppose the seller insists upon replacing the deposit bond with a cash deposit. In that case, the buyer will have to incur additional costs for the unused deposit bond, and for the cost of obtaining the required finance for the deposit. The latter may involve costly bridging finance. For this reason, always check with your vendor beforehand if you're using a deposit bond.
Who Benefits From Deposit Bonds?
Anyone planning to purchase residential or commercial property, including vacant land, or a house and land package, can apply for deposit bonds. This includes Australian citizens, permanent residents, SMSFs, trusts, partnerships and registered business entities. The property could be off-the-plan or established.
Deposit bonds are highly suited to the following buyers.
When your money is in non-liquid assets such as shares, investment properties or high-value art, you can utilise deposit bonds to your advantage. They enable you to leverage these assets as they continue to generate wealth until the settlement of the purchase.
Instead of having to wait for the 10% deposit, the bond provides you with the freedom to buy the house without delay.
First Home Buyers
Suppose you've been pre-approved for a home loan, yet you do not have access to the initial deposit. In that case, a deposit bond enables first-home buyers to pay the required deposit of up to 10% of the purchase price.
If your family circumstances have changed and you're looking to upgrade, selling your present home may provide the funds to do so. However, if your apartment gets sold, but the funds are unavailable to purchase a new home, it may go off the market. A deposit bond may help with simultaneous settlement.
How To Get A Deposit Bond?
When purchasing a property, deposit bonds are used in place of a cash down payment. This is how the procedure goes:
- Deposit bond application: Similar to the credit application process for other loans, anybody seeking to receive a deposit bond must apply to the insurer or lender providing the bond and pass the financial check.
- Presented to the seller as a deposit: The bond, a contract to pay the full deposit in cash at the time of payment, will be given by the issuer to the vendor once it has been authorised. The buyer is still obligated to pay the issuer the deposit's worth even if they breach the contract, and the seller is permitted by the agreement to keep it.
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Do You Pay Interest on Deposit Bonds?
There are no recurring fees or interest charges. However, you pay a one-off fee when the bond is issued.
When Do You Pay Back the Deposit?
When using a deposit bond, the deposit is never truly returned unless a claim is filed. The purchase amount, deposit, and other fees, such as stamp duty, are all due at settlement.
Will the Deposit Bond Be Refunded if You Don't Follow Through?
Yes, you can get a refund if the unused deposit bond is sent back to the bond provider within 30 days of its issuance.
Can I Use a Deposit Bond with a Guarantor Loan?
Yes, if there is official permission and the settlement is made within 6 months, it may be used in conjunction with a guarantor loan. However, if the settlement extends beyond 6 months or formal approval is not received, the guarantor has to sign the bond. Further, the guarantor will be liable if the buyer does not pay the deposit amount.
The information in this article is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.