What is a deposit bond?
A deposit bond can be used in place of a deposit when a buyer exchanges contracts on a property. It guarantees that the buyer will pay the full deposit by an agreed date.
If you’re planning to take out a deposit bond, you must repay the money – plus fees – to the bond issuer by an agreed date.
How does a deposit bond work?
Deposit bonds are used in place of handing over a cash deposit when buying a home. Here’s how a deposit bond works:
The buyer applies for a deposit bond from a provider, typically an insurance company or a financial institution. This involves undergoing a financial assessment to ensure the buyer has the capacity to complete the purchase at settlement.
Once approved, the deposit bond issuer will provide the vendor with the bond, which is an agreement to pay the full deposit in cash at the time of settlement. The buyer pays a premium for this bond, which is usually a percentage of the bond’s value.
The deposit bond is then presented to the seller or the seller’s agent as a guarantee for the cash deposit. It effectively promises that the bond issuer will pay the deposit amount to the seller if the buyer defaults on the contract of sale.
On the settlement day, the buyer pays the full purchase price, including the deposit. The deposit bond is not a part of the final payment; instead, it’s a guarantee that the deposit will be paid if the buyer fails to meet their obligations.
Expiration of the bond
After the settlement is completed, the deposit bond expires and has no further value. If the property transaction goes ahead as planned, the bond is not used to make any payments.
In essence, a deposit bond is a guarantee to the seller that the buyer is committed to the transaction and has the means to complete the purchase. It’s a useful tool for bridging the gap when immediate cash liquidity is an issue for the buyer. However, it’s important for buyers to understand that a deposit bond is not a way to avoid paying the deposit, but rather a way to defer the actual payment until settlement or to ensure the seller of their commitment in the absence of immediate cash.
What are the risks of a deposit bond?
Deposit bonds, while useful in certain property transactions, come with specific risks which should be carefully considered for both buyers and sellers. It’s important to understanding these risks before deciding to use a deposit bond.
The most significant risk for the buyer is the obligation to pay the deposit amount at settlement. If the buyer is unable to complete the purchase for any reason, they are still legally obligated to pay the deposit. The bond issuer will pay the deposit to the seller in case of default but will then seek reimbursement from the buyer.
Other key risks associated with deposit bonds are:
- Seller’s acceptance: Not all sellers or their agents may be willing to accept deposit bonds. This could potentially limit your options or complicate the transaction process.
- Market risk: If property values decrease between the time of signing the contract and the settlement, and the buyer decides not to proceed (defaulting on the contract), the deposit still must be paid. This situation could be financially damaging, especially in a falling market.
- Issuer’s creditworthiness: The reliability of the deposit bond depends on the creditworthiness of the issuer. If the issuer faces financial difficulties or bankruptcy, the validity of the bond could be jeopardised, which might put the transaction at risk.
- Cost: There is always a cost involved. The premium paid for the bond is not refundable, and this could be an additional expense in the property buying process.
- Settlement risk: If the buyer is relying on the sale of another property or other financial arrangements to fund the purchase, any delays or issues in these arrangements could impact the buyer’s ability to complete the property purchase, leading to potential default.
- Duration: Deposit bonds have a fixed validity period. If the settlement is delayed beyond this period, the bond may expire, and the buyer might need to arrange for an extension or a new bond, which can be challenging under certain circumstances.
How to get a deposit bond?
Although they are sometimes offered by banks and financial institutions, deposit bonds are generally issued by insurance companies.
We recommend comparing your options as well as alternatives to a deposit bond before determining if a deposit bond is right for you.
How much is a deposit bond?
The cost of a deposit bond will vary depending on the issuer. The total amount typically depends on the value of the property being purchased and the value of the deposit bond being taken out and may depend on your pre-approval status with a lender.
Rates usually vary from 1-2% of the total deposit purchase price. We recommend comparing the cost of alternatives to a deposit bond before taking one out. For example, you could compare the cost of a short-term loan against the cost of a deposit bond.
It’s also a good idea to check in advance if the deposit bond fee is refundable, partially, or fully, if the purchase does not go ahead.