What is a deposit bond?

When it comes to purchasing a home, whether it be by private sale or auction, a cash deposit is generally required to secure the property.

But if you don't have cash on hand or maybe it's yet to come through from the sale of another property, a deposit bond can be an alternative.

What is a deposit bond?

Deposit bonds act in place of a cash deposit, serving as a guarantee or form of insurance when a buyer and seller exchange contracts.

This arrangement provides assurance to the seller that the buyer will pay the complete deposit on a specified date, generally at the time of settlement. If the buyer is unable to provide the necessary funds at settlement, the seller can then claim the deposit bond from the bond provider.

There are a range of companies that offer deposit bonds in Australia, many of them insurance companies. The may also sometimes be offered by select banks and financial institutions.

How much is a deposit bond usually for?

In most cases, a deposit bond will be for the typical 10% cash deposit required on the exchange of contracts. The person taking out the bond will agree to pay the issuer back by an agreed date, plus fees.

Generally, you can expect to pay between 1.2 - 1.5% on top of the total deposit in fees. This will differ according to the provider. The total will also depend on the value of the property and how much the deposit bond is for.

The cost may also be lower if you have been pre-approved for a home loan.

Why would you use a deposit bond?

Deposit bonds can be a viable option for a number of reasons:

Speed up transactions

Deposit bonds can help speed up the process of purchasing a new home, as they eliminate the need for a cash deposit. This means the time and paperwork involved in providing proof of funds is generally not required.

Cheaper alternative than bridging finance

Many people waiting for funds to come through from another property sale will consider a bridging loan. This is essentially a short-term loan via a lender to help bridge the shortfall in funds which can happen while a previous property sale settles.

Bridging loans generally come with high interest rates and monthly repayments. Alternatively, deposit bonds generally involve a one-off fee to the bond issuer when settlement eventually takes place. This can effectively save some homebuyers tens of thousands of dollars. 

Buying property not yet built

Deposit bonds are typically tailored to specific requirements and can be used to purchase a number of different types of properties, including new builds with an extended settlement period.

Taking advantage of a deposit bond for new builds or off-the-plan properties is an alternative to buyers tying up their cash for that period, allowing them to keep their cash reserves for other purposes.

It can also allow them to take advantage of potential price increases in the property market which could result in capital gains should they decide to on-sell the property when it gets closer to settlement without ever having to have put cash down. However, you'll need to check with individual developers whether they will accept deposit bonds.

Auction backstop

While the amount of a deposit bond is generally fixed, some bond issuers may leave the vendor and property details blank so it can be used should a homebuyer be successful at auction when a cash deposit is immediately required.

This can be particularly handy if a buyer plans on attending multiple auctions within a short period. It's always wise to check first whether a deposit bond will be acceptable to all parties, however.

How do deposit bonds differ from bank guarantees?

Deposit bonds and bank guarantees are both forms of 'insurance' that a certain amount of cash will be paid, yet differ significantly in their structure.

When purchasing a property, a bank guarantee is an unconditional offer by a bank - on behalf of the buyer - to pay the seller an assured amount upon written demand. But banks require some security behind issuing the guarantee, generally the money in your savings or term deposit accounts or other property you may own.

On the other hand, a deposit bond allows the property buyer to ‘pay' a deposit without accessing cash directly from their pool of savings. Deposit bonds don't require a type of security attached for the bond to be issued.

Deposit bond pros and cons

Pros

• Cost-effective: Deposit bonds are a cheaper alternative to other forms of finance such as a bridging loan, potentially freeing up cash that can be used for other purposes upon settlement.

• Flexibility: Deposit bonds are flexible as they can be used for a range of property transactions - from new builds to established homes to properties bought at auction.

• Security is not required: Where bank guarantees require a form of security such as cash, term deposits, or even real estate, deposit bonds do not.

Cons

• Deposit-only: As the name suggests, a deposit bond can only be used for the deposit and not the entire purchase price of a property, which must be forthcoming for settlement.

• Time sensitive: Deposit bonds have an expiration date and if the transaction does not settle within the specified time frame, the bond will become void.

• Relatively unknown: Deposit bonds are a relatively rare product in the market, with many buyers unaware of the prospect of using a deposit bond as a means of putting down a deposit.

1. Savings.com.au’s two cents

Despite being an unfamiliar product in the home loan landscape, deposit bonds can be a useful tool for buyers who may be unable - or unwilling - to part with a large chunk of savings for a property deposit.

Before considering a deposit bond, it’s essential to ensure you will be able to provide adequate funds by settlement date or you run the risk of the sale falling through.

If you choose to take advantage of a deposit bond, factors such cost, duration, and terms and conditions need to be carefully considered. It's wise to engage professional financial or legal advice.

Deposit bond process

Here's a basic guide:

1. Application: Deposit bonds are not just issued to anyone. You will still need to be vetted by the bond provider in much the same way as a credit provider would assess your financial credentials to ensure your capacity to settle the full property purchase price.
2. Handing over the bond to the seller: Once an application is approved, a digital bond is issued, essentially an IOU assurance that the full deposit will be paid in cash at the time of settlement. This can be put down in place of cash at exchange of contracts stage if all parties are in agreement.
3. Property settlement: When the property settles, the buyer will pay the full purchase price (deposit plus balance) at settlement. If the sale doesn't proceed, the seller may be able to claim the bond amount from the provider depending on the circumstances.
   In some scenarios (such as a finance clause not being met), the bond becomes voided. But if the contract was non-conditional, the seller can claim the deposit amount from the bond issuer. The would-be buyer then has to repay repay that amount to the issuer, essentially turning it into a debt.