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Deposit Bonds: what are they and how do they work?
Are you looking at buying a property but worried about not having enough cash handy for a deposit? You could consider a deposit bond as an alternative. We examine some of their pros and cons.
15 May 2024
Are you looking at buying a property but worried about not having enough cash handy for a deposit? You could consider a deposit bond as an alternative. We examine some of their pros and cons.
Key points:
- Deposit bonds are used instead of cash to pay a deposit when buying a home.
- Expect to pay a fee based on a percentage of the deposit bond amount.
- Some vendors may not accept a deposit bond.
Deposit bonds could help you solve the perpetual owner-occupier property conundrum – how do you find the money to buy a new house when you haven’t sold yours yet?
The thought of selling your 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 and find funding that scenario difficult, especially if there’s 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 many companies offering deposit bonds as an alternative solution.
Home buyers should do their homework before considering deposit bonds as an option. 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.
What is a deposit bond?
The Australian Government’s Moneysmart website defines a deposit bond as a financial agreement that can be used “in place of a deposit when a buyer exchanges contracts on a property”. It is a guarantee 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. Some lenders also offer lender-issued deposit bonds on certain loans, depending on the buyer taking a loan with that lender.
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.
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 the process works:
Application
Anyone wanting to obtain a deposit bond has to apply to the insurer or lender issuing the bond, and pass financial tests (much like the credit application process that applies for other loans). For example, the company Deposit Bonds Australia (DBA, which is underwritten by QBE Insurance Australia) says 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”.
Provide the vendor with the bond
Once approved, the deposit bond issuer will provide the vendor with the bond – 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.
Why would a vendor not accept a deposit bond?
A deposit bond is a piece of paper that’s given to the vendor, rather than cash being handed over as a part of the sale process.
It’s important to bear in mind that a deposit bond may not be the right solution for every situation. For example, Rams Home Loan says some vendors may not consider a bond as appropriate collateral, and the vendor may say that they will not accept it.
If you’re considering using a deposit bond, it could be a wise idea to check with the seller’s agent to see if the vendor is okay with the idea of accepting one before you make an offer. It’s also a good idea to check the contract terms and conditions carefully to see if deposit bonds are excluded. Sometimes, a contract will stipulate that deposits must be paid in cash.
How much does a deposit bond cost?
Different issuers charge different fees for deposit bonds. The total amount typically depends on the value of the house being bought and the value of the deposit bond being taken out, as well as if you have been pre-approved for finance.
A review of several deposit bond companies suggests you could expect to pay from between 1.2% and 1.5% of the total deposit purchase price. Many deposit bond issuers have an online 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, partially or fully, if the purchase does not go ahead.
Explore: What if I change my mind about buying a house?
How long does a deposit bond approval take?
It can take just a matter of hours from the time you return an application with payment for a deposit bond to be approved and available for you to use on a contract of sale. For example, Deposit Bond Australia notes that applicants could receive their bond within four to 48 hours, depending on the complexity of the application. Deposit Assure offers bond applicants a turnaround time of less than one business hour.
What are the pros and cons of a deposit bond?
What are the potential pros of a deposit bond?
Deposit bonds can be helpful if you are waiting on your funds to come through from the sale of your home. It can also be a less expensive alternative to bridging finance, and can help you to continue to earn interest on your savings as no money is required upfront for your deposit bond. They can also be beneficial if you are waiting to buy a house that you purchase off plan as deposit bonds can remain active for four years.
What are the potential cons of deposit bonds?
The 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. This may be due to the seller wanting funds early in the process to secure their next purchase, or the real estate agent wanting to access their commission (which is usually paid from the deposit).
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).
What are alternatives to deposit bonds?
There are other alternatives to deposit bonds available to you as a potential buyer, such as:
taking out a different type of home loan offering a higher loan-to-value ratio (LVR) and paying Lenders Mortgage Insurance (LMI).
Compare Home Loans (First home buyer with a variable rate) with Canstar
If you’re currently considering a home loan, the comparison table below displays some of the variable rate home loans on our database with links to lenders’ websites that are available for first home buyers. This table is sorted by Star Rating (highest to lowest), followed by comparison rate (lowest-highest). Products shown are principal and interest home loans available for a loan amount of $500,000 in NSW with an LVR of 80% of the property value and that offer an offset account. Consider the Target Market Determination (TMD) before making a purchase decision. Contact the product issuer directly for a copy of the TMD. Use Canstar’s home loans comparison selector to view a wider range of home loan products. Canstar may earn a fee for referrals.
Owner occupied
10% min deposit
Redraw facility
Owner occupied
20% min deposit
Redraw facility
Owner occupied
20% min deposit
Redraw facility
Owner occupied
20% min deposit
Redraw facility
Image source: fizkes/Shutterstock.com
This article was reviewed by our Editor-in-Chief Nina Rinella before it was updated, as part of our fact-checking process.
Owner occupied
40% min deposit
Redraw facility
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