Deposit bond

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Deposit bonds are a type of Surety bond ― a financial instrument commonly used in Australia as an alternative to a cash deposit. Deposit bonds facilitate residential or commercial real property purchases. They are sometimes confused with deposit insurance, by which a bank's deposits are protected, but they are actually financial instruments that apply to real estate transactions.

A buyer can use a deposit bond in the place of cash, by giving the seller a deposit bond at the time of purchase. The buyer and seller both must agree that the buyer will pay the seller the total sum for the property purchased at a future date; ownership of the property transfers from the seller to the buyer on this date.

Deposit bonds provide the seller assurance that the buyer's deposit is insured, and that they will receive it in the case where the buyer fails to fulfill his or her obligation to the seller.

Assurance

Deposit bonds provide a guarantee that a transaction will happen - in other words, they provide an assurance of the transaction. Note that this is different from insurance, which provides renumeration from an event that might happen if it does happen.

Buyer

Deposit bonds are issued on behalf of the buyer, by an insurer or bank, in the form of a certificate guaranteeing the total sum of deposit money required for a real estate purchase.

Deposit bonds are typically used when a potential real estate buyer's accessibility to their own cash is limited, usually in other investment asset classes.

History

Deposit bonds were introduced in Australia in 1988 by the UK insurance giant, Royal Sun and Alliance, through their Australian-owned company called Deposit Power.

Banks and other insurance companies followed suit introducing the deposit bond into their product offerings, especially for their mortgage clients. Other financial intermediaries, such as brokers and financial advisers, have also become part of the supply chain of selling and issuing deposit bonds to the consumer. These financial intermediaries are typically authorized to act as agents for an insurance companies or banks.

New Zealand and the United States are the latest markets to embrace the deposit bond in the last few years. In the United States, deposit bonds are known as bond down payment bonds

Risk Mitigation

Banks and insurance companies have their own underwriting guidelines in relation to issuance of Deposit Bonds that people will need to meet.

Underwriting guidelines vary from company to company, but generally the bond issuers look for the following:

  • asset and liabilities
  • ability to gain or have finance approval in place

The risk is borne by the issuer of the deposit bond ergo the financial institution or insurance company, on behalf of the buyer.

If the buyer fails to fulfill their agreement, the seller is entitled to keep the security deposit which was held as collateral and in lieu of cash for the real estate purchase.

Therefore, upon claim, the funds will be paid out immediately by the issuer of the bond to the seller. Being an assurance, the event is covered no matter what.

References

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