Deposit bond: What it means & how it works

A deposit bond is a guarantee a buyer provides to a seller, promising that the deposit can and will be paid at a later date.

Whatever your reason for considering a deposit bond, we have all the answers to your pressing questions.

What is a deposit bond?

When you agree to buy a property, the seller will want you to put down a deposit to secure it. That way, if you later back out or can’t cough up the funds during settlement, they won’t walk away empty-handed. 

A deposit bond is a financial guarantee provided by the buyer to the seller, assuring them that the money is as good as theirs. 

It’s typically provided by an insurance company, with QBE Insurance underwriting many of those on the Australian market. However, banks and lenders can sometimes provide deposit bonds too.

Deposit bonds can be useful in many scenarios, such as:

• Building an off-the-plan property
  Avoid losing access to your deposit during the construction period

• Buying a new home before selling your current one
  Sidestep taking out a bridging loan or implementing a 'subject to sale' clause

• Waiting for funds
  For instance, you might be waiting for a first home owner grant or inheritance

• Better uses for your cash
  Keep your money in a savings account, term deposit, or offset account for as long as possible

• High loan-to-value ratio (LVR)
  If you’re taking out a home loan with a high LVR, perhaps thanks to having a home loan guarantor, you mightn’t have access to the funds needed for a deposit until your lender pays out at settlement

When you opt for a deposit bond, you'll be required to sign an indemnity agreement. This legally binding document ensures that if you default on the contract at settlement, the insurer has the right to recover the funds from you. 

Deposit bonds are typically limited to up to 10% of the value of a property and can commonly have a lifespan of up five years.

How does a deposit bond work? 

Here’s the process a residential property buyer will typically take if they’re planning to use a deposit bond:

1. Find your dream home or investment property 

This part is pretty easy. After all, who doesn’t like browsing real estate sites, attending open homes, and scrutinising floor plans? And nothing beats the high of finding the perfect abode.

Now could be the time to apply for a deposit bond. Though, you might need to know the exact property you plan to buy in order to apply. Check with your preferred provider to find out when to apply.

2. Put in an offer

When you find the perfect place, it’s time to put in an offer. 

If you’re planning to use a deposit bond, make sure you mention it, as well as any other clauses, such as a subject to finance clause, in the offer.

3. Arrange for finance

Once you get to this stage, it means your offer has been accepted. Congratulations!

If you haven't secured your deposit bond yet, now's the perfect time to do it. Many providers can give you an answer within hours, so you won't have to spend your weekend anxiously waiting for a response.

It’s also the time to start checking in with your lender if you’re planning to take out a home loan.

The seller will likely take the deposit bond around this point of time. Don’t worry, they shouldn’t make a claim for the cash unless you back out of the sale for a reason not stipulated in a clause.

4. Settlement

Now the hard work is over for you and your conveyancer or solicitor will take the reins. They’ll make sure everything is hunky-dory with the property and prepare all that’s needed for you to hand over the money and the seller to hand over the title.

Since you have a deposit bond, you’ll need to pay the entire asking price on settlement day, with help from your lender if you’re taking out a mortgage.

The deposit bond will then be negated and you can celebrate your purchase.

How much do deposit bonds cost? 

Deposit bonds aren’t free to use, but they might be a cost effective way to navigate the home buying process in certain situations.

If you’re hoping to settle within a few months, as is typically the case with residential property purchases, your deposit bond provider will likely charge a set fee based on the size of the bond. This is often paid when it issues your deposit bond.

If you’re planning on holding a deposit bond for longer than a few months, such as when buying an off-the-plan property, your provider will normally demand a portion of the value of the bond back for each year it’s outstanding.

Are you eligible for a deposit bond?

Like just about any finance product, a person applying for a deposit bond must meet certain eligibility criteria in order to be successful. 

The exact criteria differs significantly between deposit bond providers.

Typically an applicant needs to have enough in assets, income, or both to suggest that, if they default on the contract at settlement, the insurer can recover the deposit from them. 

Though, some providers want to see that you either have the cash ready to go or you have unconditional approval from a home loan lender.

Others even demand applicants already own property or someone close to them can offer their property up as a form of security in case they default on their agreement.

What are the risks of using a deposit bond?

While deposit bonds can help those in unique circumstances to climb the property ladder, they’re not always a perfect solution.

Anyone taking out a deposit bond should consider doing so carefully and dedicate time to researching pros and cons individual to their situation. It could be wise to seek advice from a financial planner or lawyer before signing on the dotted line.

Major drawbacks of deposit bonds include:

Risk of losing more than you have

There is the risk that, if something goes wrong, you could stand to lose cash that you don’t actually have. That could put you in hot water, financially and legally. 

Time constraints 

There’s also risk surrounding the time in which you can hold the deposit bond. For instance, if you’re buying an off-the-plan property, you might take out a deposit bond for five years – the maximum time frame typically available. If your build takes longer than that to complete, you might be left scrambling. 

Deposit bonds aren’t as widely accepted as cash 

You’d be hard pressed to find a seller that won’t accept cash in a property transaction. Cash is easy, it’s simple, and it's secure. It is king, after all.

On the other hand, vendors don’t have to accept deposit bonds.

If a seller receives two similar offers, one cash and the other including a deposit bond, they might be tempted to go with the cash offer for the sake of convenience and surety. 

All that is to say, if you’re looking to buy, particularly in a hot market, a deposit bond could slow you down. 

---

Considering entering the property market for the first time, or moving into your dream home? Here are some of the most competitive home loans available now:

Important Information and Comparison Rate Warning

_{Image by alise storsul on Unsplash}