Any prospective or successful bidders need to know all the options available to them when it comes to the property sale process. If you’re gearing up to dip your toes into the housing market, it may be worthwhile taking deposit bonds into consideration, as they provide a slew of potential benefits to the savvy buyer.
Deposit bonds offer a time-saving and cost-effective alternative to cash deposits that are required when purchasing a home. You may not want to dip into that golden piggy bank account just yet, or break that fixed term investment you’ve been grinding away at.
At Homestar Finance, we recognise the fact that the property market can be painstaking to navigate on your own. So whether you’re someone looking to upgrade on your current humble abode, or a first home buyer, we’re here to answer any questions you may have regarding deposit bonds and how you can leverage them to your advantage.
What is a deposit bond?
Normally, a cash deposit is a necessary initial step in purchasing a property or bidding at an auction. However, deposit bonds are an alternative form of guarantee that don’t require an upfront payment of cash.
In Layman’s terms: A deposit bond is an insurance policy that indicates the buyer’s commitment and ability to pay the full deposit amount at the time of settlement.
This means that the buyer is essentially able to delay any cash repayments including the purchasing price and the deposit amount until the settlement date. If the buyer is unable to produce the funds at settlement, then the seller will claim the deposit bond from the bond provider.
Benefits of a deposit bond
Deposit bonds provide the buyer with a wealth of benefits, usually allowing for faster transactions, cost savings and more monetary freedom when it comes time to purchase.
Benefits of utilising a deposit bond include but are not limited to:
- Secures your property purchase faster since cash deposits often take time to organise
- Helps avoid any short-term loans such as bridging finance to cover the cost of the deposit
- Valid for both short and long term loans
- Allows you to keep long term investments in place to continue generating income until settlement
- Allows you to keep cash in your savings to earn interest until settlement
- Can be used for auctions and private exchanges (subject to prior vendor approval)
- A deposit guarantee only requires a one-off fee compared to a bank guarantee which usually involves higher set-up fees and ongoing costs
- Turnaround time for a deposit bond application is quick, usually within 24 hrs
Risks of a deposit bond
As with any contract of sale, there are indeed some risks associated with deposit bonds.
Here are some of the factors that you should be aware of:
- Some vendors may be reluctant to accept deposit bonds as they are selling the property for the purposes of liquidity, i.e. in order to fund the purchase of an alternate property or a loan repayment
- Certain contract terms may specify that a cash deposit is mandatory
- A real estate agent may refuse deposit bonds since they are typically paid from the deposit and the use of a bond would not allow for the early release of their commission
- The applicant has to go through a financial check to ensure they meet certain financial eligibility criteria, such as the ability to pay the deposit and purchase price, as well as any other costs associated with property purchase
Should I get a deposit bond?
At the end of the day, it really comes down to personal circumstances when determining whether or not a deposit bond would work for you.
Although it is down to the buyer’s discretion, see below for some situational examples where deposit bonds might come in handy.
Scenario 1:
You’re an investor
You may be someone who has diversified their wealth through high-interest savings, shares, investment properties or high-value collectibles such as art. Whichever it is, when you have money tied up mostly in non-liquid assets it can be tricky or counterintuitive to dip into these assets for the purposes of a deposit. In this case, utilising a deposit bond can help leverage these assets so that they can continue to generate income until the eventual settlement of the purchase.
Scenario 2:
You’re a first home buyer
Purchasing your first home can feel like an endless barrage, when you have so many outgoing expenses and upfront costs to factor in. Not to mention the stress associated with home loan approval. Luckily, utilising a deposit bond can help alleviate some of the early pressures and upfront costs. If you know that you are able to afford the property and have been pre-approved for a home loan, yet you do not have ready access to the initial 10% deposit, you may be suitable for a deposit bond.
Furthermore, if you are making use of the FHOG (first home owner grant) it’s worth noting that the amount will be paid to you at the time of settlement if you are buying and not building.
In any case, for many first home buyers, deposit bonds can be an ideal way to avoid upfront costs. We understand that the path to your first home isn’t always smooth sailing, so if you need a hand with budgeting, Homestar’s budget planner calculator can help you navigate the minefield towards greener pastures.
Scenario 3:
You’re an upgrader
You’ve gotten married and had kids. Before you know it, the 2 bedroom apartment in the heart of the city has slowly begun to feel less like a bachelor’s paradise and more like a can of sardines. You want to retreat into a nice lavish 3-bedroom house in quiet Australian suburbia and selling the apartment would provide the funds to do so. Unfortunately, simultaneous settlement can be a nightmare for those looking to move on swiftly from their sale. The apartment has sold, but the funds are not yet available to use for your new home that may disappear off the market any minute. You get the picture.
Am I eligible to get a deposit bond?
Anyone looking to purchase a residential or commercial property can apply for a deposit bond. Eligible entities can include but are not limited to:
- Australian citizens and permanent residents
- Trusts
- Self-managed super funds
- Registered business entities
- Partnerships
You may also be asking yourself “How does the approval process for deposit bonds work?”
When you apply for a deposit bond your eligibility will always be considered on a case-by-case basis, but there are three general rules of thumb when it comes to obtaining approval for a deposit guarantee.
- Does the buyer have a formal approval or at the very least a conditional finance approval?
- Will settlement take longer than 6 months? This may be because you are purchasing off the plan or at an auction. If yes, then the bond issuer will need to conduct an asset and liability assessment.
- Are you currently in the process of selling an existing property? When the incoming funds from a property sale are enough to facilitate the purchase of your new property, you will almost always be eligible for a deposit bond
How to get a deposit bond
Along with these main considerations, it is worth keeping in mind the main documentation you have to provide in order for the bond issuer to approve your application.
In order to properly assess your financial situation issuers may require the following:
- A copy of the contract of sale
- Evidence of sufficient funds such as savings, share certificates, fixed-term deposits, etc.
- Evidence of guaranteed future funds, such as the FHOG
Getting a deposit bond when buying off the plan
Buying off the plan means purchasing a property based on building plans and designs prior to the finished product. Naturally, there are some risks when it comes to buying a house that is still under construction or hasn’t even been built yet. However, using a deposit bond can help to alleviate some of the major monetary risks.
As long as the property developer is willing to accept a deposit bond, securing the purchase through this method can provide big money-saving benefits.
Typically, developers will ask for a 10% deposit that is to be held in a legislated trust account and invest this money for development purposes. You are then expected to pay the balance upon completion. By utilising a long-term deposit bond in lieu of a cash deposit, you can make the most of your savings and help with financial pressures in the short term. Moreover, if settlement occurs 6 months prior to the expiry of your bond, you may be eligible for a full pro-rata refund.
Buying off the plan means that the deposit bond will need to be issued until the sunset clause specified within the contract. Long-term deposit bonds can last anywhere up to 4 years, which is usually the same time as the completion of the property.
Frequently asked questions about deposit bonds
How much does a deposit bond cost?
The cost can vary according to the issuer’s terms and conditions. Generally speaking, most providers construct their fee depending on the deposit bond amount, as well as the bond term.
However, in the case of a short-term deposit bond (less than 6 months), the standard rate is usually a one-off fee of 1.3% of the deposit required. Comparatively, short-term loans can range anywhere between 8-13%.
Take the given scenario:
Todd plans to purchase a home off the plan for $900,000. He has all of the cash required, but it is tied to his long-term investment portfolio and will have early access fees if withdrawn within the next 4 months. He plans to use a deposit bond until he is able to withdraw the cost of the full purchase price.
In this case:
$900,000 x 0.1 = $90,000 (deposit amount)
$90,000 x 0.013 (standard rate for < 6 months) = $1,170
Todd will pay a deposit bond fee of $1,170
If Todd had taken out a short-term loan at an interest rate of 8%, he would be looking at $7,200. Meaning that using a deposit bond has saved him $6,030
How long does it take to issue a deposit bond?
The time it takes for your application to be approved depends heavily on the provider, but generally, it takes a lot less time than you expect. Upon submitting the necessary documentation, pre-approval can take anywhere between 15 minutes to a couple of hours.
Most of the time, once the contract has been signed, the deposit bond will be dispatched straight away and will be sent to all relevant parties within one business day.
The speed is another reason why many opt for deposit bonds rather than a short-term loan.
When do I pay back the deposit?
The deposit is an assurance that the vendor will guarantee the funds for the vendor until the time of settlement. Therefore, you never actually pay back the deposit unless there is a claim made by the vendor.
When it comes time to settle, you just need to pay the full purchase price along with the deposit and any other fees such as stamp duty or mortgage registration.
Do you pay interest on a deposit bond?
You will be happy to know that unlike other costly bridging finance options, there are no additional costs on top of the one off fee paid to the issuer when obtaining the deposit bond.
This is another reason why deposit bonds are such an attractive option to those who do not have much ready cash available.
What is the difference between a deposit bond and a bank guarantee?
Bank guarantees and deposit bonds are both forms of insurance that indicate to the seller that the liabilities of the buyer will be met by the lending institution if the buyer is unable to settle the debt.
However, there are some important differences to note.
Bank guarantees are secured, meaning that they are tied to assets such as real estate or cash security. This means that bank guarantees have higher set-up fees, as well as ongoing costs compared to the one off fee paid for a deposit bond.
On the other hand, deposit bonds are unsecured which means they are not tied to any assets and can be much quicker to obtain than the former.
What documents are required when applying for a deposit bond?
This can also vary depending on the situation, but some of the essential documentation required for the approval of a deposit bond are:
- Photo ID or other primary forms of identification
- Proof of funds (as mentioned earlier)
- Letter from your lending institution for finance approval
- Contract of sale for the purchase property
- Contract of sale for the selling property in the case of simultaneous settlement
- Proof of income
If settling within 6 months, issuers also require:
- Liability statements from your home loan
- Rates notices for any owned properties
Identifying whether or not a deposit bond works for you can potentially save you thousands of dollars whilst dually speeding up the sale process. Any potential buyers should carefully examine their situation to see if a deposit bond can help them reap any of the aforementioned benefits.
The dreaded deposit is just the first stage in consolidating your new home, but hopefully this article has provided some insight into making this process easier. Whether you’re looking to buy your first house, refinance your current home loan, or just curious to assess what options are out there, head on over to Homestar to see the best of what’s out there.
Disclaimer: This article is not intended as legal, financial or investment advice and should not be construed or relied on as such. Before making any commitment of a legal or financial nature you should seek advice from a qualified and registered Australian legal practitioner or financial or investment advisor.
