A deposit bond is essentially an unsecured guarantee by the underwriter, usually an insurance company, to the vendor guaranteeing payment of the deposit on the settlement date.
The major advantage of a deposit bond is that, as an unsecured facility, it can usually be issued within 24 hours after approval. However, depending on which state the property is located in, real estate agents and/or vendors may be reluctant to accept a deposit bond as a satisfactory payment of a deposit. For example, there is a high degree of resistance in the Melbourne market. One of the main reasons for this is that under section 27 of the Sale of Land Act a vendor can request a purchaser to release the deposit monies prior to settlement. This allows the vendor to use these funds to pay the deposit on a subsequent purchase and the selling agent to deduct their commission and costs. If the deposit is paid using a deposit bond, neither the vendor nor the selling agent can access any monies before settlement.
Deposit bonds have a minimum term of three to six months irrespective of the settlement term and the premium for the bond is paid up front. It is more expensive for an investor to use a deposit bond than cash, although it may be less expensive than using borrowed funds.
An investor planning to purchase an established property using a deposit bond would need to either make the purchase conditional on the payment of the deposit by a deposit bond within a certain time frame or seek approval and issue of the bond prior to purchase, especially if purchasing at an auction. While the address of the property and purchase price may not be known, the bond could be approved and issued for a maximum amount. The details of the address of the property being purchased, the amount of the deposit payable and the name of the vendor can then be completed and the bond signed by the purchaser at the time of completing and signing the contract of sale.
If an investor intends to purchase an established property for a maximum of $500,000, they can organise for a deposit bond for this maximum deposit of $50,000 to be approved and issued. Should the investor ultimately purchase for less, they can complete the deposit bond for the lesser amount.
Deposit bonds can be an ideal solution for investors who do not have sufficient cash and provided the selling agent/vendors are agreeable.