A cash deposit is not the only way to get your hands on the home of your dreams
But a little known de facto ‘‘insurance policy” may be the key to allow these people to commit to a purchase before they settle without going through a costly bridging loan or time-consuming refinancing.
A deposit bond allows buyers to exchange on a property without having to provide a 5 or 10 per cent cash deposit. Corey Beaver, a Sydney-based mortgage broker with Experity, says: “In a recovering property market where buyers need to put their deposit money down quickly to secure a property, having a deposit bond can mean the difference between getting the property or missing out.”
Deposit bonds can be approved in a couple of hours and provide the seller of a property with a guarantee that the buyer is able to fulfil their commitment of a 5 or 10 per cent deposit. If the buyer fails to settle, the deposit bond provider will pay the agreed deposit to the seller and will separately chase the buyer for the deposit.
As no cash is exchanged between buyer and seller under a deposit bond arrangement, they tend to suit transactions where the seller does not need to access the deposit early to enable them to purchase another property. However, not all real estate agents and sellers are aware of what a deposit bond is, so some educating and convincing may be required.
It is important to note that not everyone will be approved for a deposit bond. The deposit bond provider needs to know that you are good for the 5 or 10 per cent deposit that they are guaranteeing. This is done by verifying that you have sufficient assets such as cash, shares or property. Once approved, the deposit bond is generated and provided to the seller in order for contracts to exchange.
This is how a deposit bond can work in practice: Beaver at Experity recently helped a client who was selling their $1.8m Sydney home and buying a cheaper $1m home in Queensland. Beaver says: “The client had minimal cash on hand as their main asset was their Sydney home. Although they were downsizing and freeing up hundreds of thousands of dollars post-purchase, the main problem was that they needed some way to fulfil the 10 per cent deposit requirement in order for both properties to settle simultaneously.”
The cost of the $100,000 deposit bond in this instance was $1300 for 90 days. If you annualise the cost of the deposit bond, it works out to be around 5.2 per cent interest, which is on par with current home loan interest rates.
And it’s not just people who have equity tied up in the family home who might find a deposit bond useful. People with share-based investments who do not wish to liquidate right now (or cannot sell due to employee trading window restrictions) might use a deposit bond.
Similarly, people with fixed-term investments with maturity on the horizon could use a deposit bond if breaking the investment early means a high penalty cost. Auctions are another scenario where deposit bonds can be useful. If the buyer is not sure whether they will win or not, rather than reorganise their finances to free up the deposit, using a deposit bond allows them to buy if they are successful at the auction. Alternatively, the bond can be reused if unsuccessful the first time round.
Deposit bonds may also come in handy because of the speed at which they can be issued, and may suit people who are looking to buy before the property market takes off again. The alternative is to refinance their existing debt to free up a deposit, which may take weeks or months to complete.
Beaver says: “Talking to a good mortgage broker is important so that you have a seamless connection between the deposit bond provider and the bank which will ultimately provide the finance for the new property purchase.
“Although going directly to your existing bank may seem the safest thing to do, banks tend to focus on their own products and you are unlikely to get the more holistic and solutions-based approach that you would from an external mortgage broker, which includes looking at deposit bonds.”
Now that interest rate relief appears to be on the horizon, buyers are starting to come back into the market and sniffing around for bargains, hoping to get in just before the next property boom cycle. Deposit bonds can be used for owner-occupiers, investment purchases, commercial properties and self-managed super funds. But make sure the vendor is willing to accept one before you start the process and that you have the ability to settle the property; otherwise the property deposit provider will be hot on your tail to recoup their deposit after a failed settlement.
James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au
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