Deposit bonds could help people solve the perpetual owner-occupier property conundrum – how do you find the money to buy a house when you haven’t yet sold yours, and don’t want to sell it until you can find one to buy?
The thought of selling a house and having no home to move into on settlement day is a complication many homeowners would dread. That’s why some might consider buying a house before they sell their home, only to find funding that scenario difficult, especially if there is a mortgage on their existing property. While there are other options available – such as bridging finance or buying a home subject to the sale of yours – there are also many companies offering deposit bonds as an alternative solution.
Lawyers Conveyancing principal lawyer Peter Mericka told Canstar that in his experience, many home buyers were unaware of the availability of deposit bonds until they find that they can’t come up with a cash deposit, and then are “told by loan brokers or they find out via the internet”.
However, he also suggested that home buyers need to do their homework before considering them as an option. And it’s wise to talk to the person selling the property or the real estate agent and seek expert financial or legal advice before signing any deposit bond agreements.
We take a look at some of the possible pros and cons of taking on a deposit bond:
What are deposit bonds?
The Australian Securities and Investments Commission defines deposit bonds as a financial agreement that can be used “in place of a deposit when a buyer exchanges contracts on a property”, guaranteeing to the seller that the buyer will pay the full deposit on an agreed date. Although they are sometimes offered by banks and financial institutions, deposit bonds are generally issued by insurance companies.
Deposit bonds are used instead of cash to pay a deposit when buying a home, usually providing cover for up to about 10% of the purchase price. The person taking out the bond has to pay the money – plus fees – back to the bond issuer, and not the property vendor, by an agreed date.
Mr Mericka said a deposit bond could make it possible for a purchaser without ready access to cash to secure a property by using a deposit bond in lieu of cash.
“The bond is really an insurance policy under which the insurer will pay the vendor the value of the deposit if the purchaser defaults, and it is then up to the insurer to chase the purchaser to recover the funds,” Mr Mericka said. “If all goes as it should, the bond is surrendered at settlement, and the full purchase price of the property is paid at settlement as well.”
However, bear in mind that a deposit bond may not be the right solution for every situation. For instance, according to Newcastle-based law firm Baker Love Lawyers, there is a risk that some sellers “may refuse to accept a deposit bond”, particularly if they need early access to the deposit money to buy a new house of their own. Baker Love warns that as a buyer, you may incur additional costs if you try to use a deposit bond and the seller hasn’t agreed to this beforehand.
How do deposit bonds work?
Anyone wanting to obtain a deposit bond has to apply and pass financial tests, much like the credit application process which applies for other loans. The bond issuer will ask for financial information and check your credit score, in most cases, or it may use information provided by your bank, if you have been referred that way.
For example, the company Deposit Bonds Australia (DBA, which is underwritten by QBE Insurance Australia) states that its deposit bonds are “only issued to qualified purchasers who have met QBE’s credit criteria and DBA’s assessment process of their financial capacity to settle the full property purchase price”.
DBA adds that the “DBA/QBE process to qualify purchasers’ financial position is equivalent to standard … residential or commercial lending criteria which reduces the Vendor’s settlement risk by Purchasers proving their capacity to pay 105% [of the] purchase price before exchanging contracts rather than just paying [a] 10% deposit without qualification.”
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. If the buyer defaults on the contract, and the vendor is eligible under the contract to keep the deposit, the buyer still has to pay the issuer the value of the deposit, plus any fees.
How much do deposit bonds cost?
Different issuers charge different fees for deposit bonds. The total amount typically depends on the value of the house being purchased and the value of the deposit bond being taken out, as well as if you have been “pre-approved” for finance. A survey of several deposit bond companies suggests that you could expect to pay from between 1.2% and 1.5% of the total purchase price. Many deposit bond issuers have a calculator that allows you to get an estimate of costs before you investigate further.
It could be a good idea to compare the cost of alternatives to a deposit bond before taking one on. For example, you could compare what a short-term loan could cost against the total cost of a deposit bond. It’s also a good idea to check in advance if the deposit bond fee is refundable if the purchase does not go ahead.
You may also find interesting: How does the First Home Loan Deposit Scheme work?
What are the pros and cons of deposit bonds?
Mr Mericka said deposit bonds could help people buy property when they didn’t have “ready cash”, which is “to the benefit of both vendor and purchaser”.
“Some young purchasers may want to call on parents for a cash deposit or family guarantee, and a deposit bond saves the embarrassment of asking and of a refusal in such circumstances,” he added.
He said risks associated with the use of a deposit bond may include the unwillingness of a real estate agent or vendor to accept one as part of the contract conditions.
Another risk of using a deposit bond is that applicants must pass financial checks by the issuer, by law. Like home loans, deposit bonds are a form of credit and are covered by the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act), which includes the National Credit Code (NCC).
Anyone using a deposit bond is usually required to pay fees and charges on top of the amount covered by the deposit. It is generally a good idea to find out exactly how much a deposit bond will cost before entering into any agreement, or to seek professional legal and/or financial advice on whether a deposit bond is right for you.
There are other alternatives to deposit bonds available to buyers, such as bridging loans, parental guarantees or taking out a different type of home loan offering a higher loan-to-value ratio (LVR) and paying Lender’s Mortgage Insurance (LMI).
A special case: Deposit bonds in Victoria
Buyers in Victoria should take particular note when thinking about using a deposit bond, Mr Mericka said.
He said that in his experience as a Victorian lawyer, deposit bonds are “rarely” used there, because of a provision in section 27 of that state’s Sale of Land Act 1962, which allows for the early release of cash deposits. He said some contracts drawn up by Victorian agents even stipulate that deposit bonds would not be accepted as part of the sale process.
He said in his experience, some estate agents try to dissuade the vendor from accepting a deposit bond in lieu of a cash deposit, “sometimes telling the vendor that it’s better for them to have the cash early to use as their own deposit on another purchase”, for example.
“However, the truth is that the estate agent gets an early payday, because the commission is allowed to be deducted from the deposit before it’s handed to the vendor.”
He said many lawyers and conveyancers “would like to see Section 27 and its related provisions repealed, to bring Victoria into line with other states that don’t explicitly allow for the early release of cash deposits”.