Deposit Bond FAQ

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Sometimes a purchaser does not have the ready cash to be able to pay a 10% deposit on the purchase of a property. This can result in both the purchaser and the vendor missing out on a sale. The deposit bond is an alternative to a cash deposit.

Lawyers, conveyancers, estate agents and consumers are often confused about the merits of the deposit bond. If used properly, and in accordance its terms and conditions, a deposit bond be of benefit to all parties involved in a real estate transaction. However, it is important to know the limitations and rules associated with the use of the deposit bond.

In this article, subject to our disclaimer, we identify some of the benefits and problems associated with deposit bonds, and set out some strategies for ensuring that those who rely on a deposit bond do not expose themselves to unacceptable risk.

What is a deposit bond?
Why use a deposit bond?
Are there any problems with deposit bonds?
Does a vendor have to accept a deposit bond?
Does the deposit bond cover the purchaser?
Who can use a deposit bond?
What types of deposit bond are available?

What is a Deposit Bond?

Basically, a deposit bond is an insurance policy. The deposit bond is the policy document that tells the vendor that the insurance company will pay the 10% deposit to the vendor in any of the circumstances where the deposit would ordinarily be forfeited by the vendor.

No money actually changes hands under the deposit bond. Instead, all purchase funds are paid at settlement. In the ordinary course of events settlement takes place, the purchase price is paid in full, and the deposit bond simply lapses.


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Why use a Deposit Bond?

There are numerous benefits in using a deposit bond, including:

  • Savings remain intact, continuing to earn interest;
  • Expensive time delays and bridging finance can be avoided;
  • Can enable a purchaser to buy “off the plan“;
  • Can enable a purchaser to buy at auction (be sure to inform the auctioneer first); and
  • Some deposit bonds can be used for up to 4 years.

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Are there any problems with Deposit Bonds?

There’s always a negative side; and deposit bonds have their own problems:

  • Vendors who want an early release of the deposit so as to be able to pay a cash deposit on another purchase may be reluctant to accept a deposit bond;
    ;
  • Estate agents are paid their commission from the deposit. Some estate agents have been known to refuse to receive an offer from a purchaser where a deposit bond is to be used;
  • A purchaser using a deposit bond can be trapped if the contract does not specifically state that the deposit can be paid by way of a deposit bond (see next heading about this).

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Does a vendor have to accept a deposit bond?

We have seen deposit bonds cause a great deal of trouble where their use has been unexpected. This is because a deposit bond is NOT recognised as a true deposit.

Where a contract of sale states that a deposit is to be paid, the deposit must actually be paid. If we recall (see above) that a deposit bond is really no more than an insurance policy, issued on the basis that the full purchase price will be paid at settlement, we can see that the deposit bond is a “just in case” measure as far as the vendor is concerned.

If the vendor is relying on early release of the deposit from a sale in order to fund the payment of a cash deposit on a purchase, problems can arise if the vendor is “taken by surprise” with the delivery of a deposit bond in place of a cheque for a cash deposit. The vendor is entitled to demand that the terms of the contract be honoured, and may allege breach of the contract if the purchaser uses a deposit bond.

But this is just the start of the problem for both parties. If the vendor insists upon the purchaser replacing the deposit bond with a cash deposit, the purchaser will be forced to incur additional costs: first for the wasted deposit bond, and then for the cost of producing the cash required; the latter often involving costly bridging finance.

Having been forced to incur costs and suffer inconvenience, the purchaser is unlikely to consent to the early release of the cash deposit to the vendor, thereby ruining the vendor’s plans. The two parties end up at loggerheads, with both suffering unnecessarily.

The lesson that comes out of this is that a purchaser using a deposit bond should always seek the vendor’s agreement beforehand. (See our “Consumer Alert” about this on The Real Estate Blog).


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Does the Deposit Bond cover the purchaser?

We have mentioned that the deposit bond is a form of insurance policy, but it is for the vendor’s benefit only. If the insurer is required to pay the vendor pursuant to the deposit bond, the insurer will then look to the purchaser for recovery of the amount paid. It is important to remember that the purchaser remains responsible for completion of the contract, including the payment of any costs and penalties associated with a default. The deposit bond is simply a means by which the vendor can be assured that a sale to the purchaser with the deposit bond is safe.


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Who can use a Deposit Bond?

The deposit bond can be used in a variety of situations. The most common use of deposit bonds are where:

  • The purchase is off the plan;
  • The purchaser is waiting funds to come through from another source;
  • The purchaser is an investor with equity in their home but no liquid assets;
  • People intending to bid at auctions;

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What types of Deposit Bond are available?

The most common types of deposit bond are as follows:

  1. Deposit bond on loan approval – This deposit bond follows upon on the lender’s home loan approval process. (Usually unconditional loan approval will have to have been granted, although where a purchaser is buying at auction an approval subject to valuation only is usually acceptable.) These deposit bonds have the lowest costs and have up to 12 months validity;
  2. A deposit bond not requiring approval from a lender – This deposit bond is not attached to a lender’s loan approval process. Applying for this type of deposit bond is more involved and the paperwork involved is similar to that involved in applying for a loan. Because of the additional work in assessing the deposit bond application, this type of deposit bond is more expensive. A deposit bond of this type can be valid for up to 48 months;
  3. The “low docs” deposit bond – A “low docs” deposit bond is secured on available equity in the purchaser’s existing property. The purchaser “self certifies” income, and need to provide minimal documentation to confirm:
    – The deposit bond applicant’s identity;
    – The Capital Improved Value for your property being offered as security for the deposit bond;
    – Repayment history on the existing mortgage of the deposit bond applicant (if applicable); and
    – A copy of the contract of sale relating to the purchase by the deposit bond applicant.

To determine eligibility for a deposit bond, an intending deposit bond applicant should calculate by adding the amount to be secured by the deposit bond to the outstanding loan balance on the security property. As long as the total is under 80 per cent of the value of the security property, a deposit bond application is likely to be accepted.

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