Deposits vs deposit bonds

When you commit to buying a home, should you use a deposit or a deposit bond, and what’s the difference between the two? 

You have found your dream home and it’s time to make an offer. 

As part of the process, you may need to explore the option of putting forward a deposit bond. Here’s what you need to know about how this differs from a 10% cash deposit. 

Deposit vs deposit bond

During a property transaction, a deposit is a sum of money the buyer pays to the seller as a show of good faith and a commitment to the sale. Typically, the deposit is a percentage of the purchase price of the property, usually around 10%. The deposit is transferred when contracts are exchanged and generally the real estate agent acting on behalf of the seller will hold it in a trust account for safekeeping until settlement and the remaining funds are transferred. 

Deposit bonds, on the other hand, are a type of guarantee a buyer can use in place of a cash deposit. They are essentially an insurance policy which guarantees you will pay the deposit at settlement. A deposit bond is issued by an insurance company and is typically for the same amount as the cash deposit would be. The cost of a deposit bond is usually a percentage of the deposit amount, a one-off premium which you pay upfront.

Buyers offer deposit bonds because they do not have enough cash for a deposit to hand. This may be due to: 

• borrowing with the help of a guarantor
• loan approval based on equity or non-cash assets
• the buyer planning to sell their home after they make a purchase
• a deposit bond making more financial sense than putting a large sum of cash into a holding account for several weeks.

Using a deposit bond means there is no transfer of funds at the time of exchange of contracts. Instead, an insurance company guarantees to pay the deposit amount to the seller if the buyer fails to do so at settlement. 

How deposit bonds work 

Deposit bonds act as a substitute for a cash deposit. They are like an ‘IOU’ for the deposit amount. 

If you’re a buyer, once you have pre-approval for the full loan amount, you can make an offer and be clear about planning to use a deposit bond. You will then lodge the deposit bond with a provider. The deposit bond provider will issue a deposit certificate to guarantee the deposit so the property can be secured. 

When the purchase settles, you/your lender will transfer the full amount to the seller and the deposit bond provider’s involvement will end. 

Risks involved with deposit bonds

Deposit bonds are common but there are some risks involved. 

A cash deposit is generally seen as a more secure option than a deposit bond because the funds are held in a trust account and can be used to cover any expenses incurred by the seller if the buyer fails to settle.

With a deposit bond, the seller is relying on the deposit bond provider to pay the deposit if the buyer defaults. While deposit bonds are issued by reputable insurers and are considered a secure form of guarantee, there is still a risk the deposit bond provider may not pay out in the event of a claim. As a result, some sellers may prefer to accept only cash deposits as a means of reducing their risk. 

If you’re a buyer, it is important to check with your lender and the seller’s agent to find out if a deposit bond will be accepted. If you’re selling, speak to your agent about their recommendations when it comes to accepting a deposit bond. 

At Ray White Collective, because we deal with many investors and buyers who are selling at the same time as they are putting in offers, we are happy to explain how deposit bonds work and find a solution all parties are comfortable with. Reach out to us to find out more. 

Hope you enjoy the read.

Matt Lancashire