John (Brisbane)
Reply: 1.1.1.1
From: Mike .
How Deposit Bonds Work
From: John (Brisbane)
Date: 14 Feb 2001
Time: 10:33:01
Hello Sim’, I’m with you there buddy!
I've done the HK course, so I'll tell you what I know.
You get a Deposit Bond from Deposit Bond Australia (DBA, AKA CGU Insurance) or a Bank Guarantee from your own bank if you are a high net worth individual. Both are essentially the same thing, but from different sources. You need over $45k/yr income and great credit rating to get just one deposit bond. Getting two is harder, getting three is very difficult. Hence a good relationship with a bank is a cheaper and more flexible option for this type of product. (Note To Self: shouldn’t use flexible and bank in same sentence) They are priced according to your credit risk, size of the bond, and duration of the bond.
A deposit bond is a guarantee by a third party that the vendor will get the bond in cash if she/he has right to it. If you enter into a contract on a long settlement period (over 120days) then the vendor will want this guarantee up front in case you default prior to settlement. The amount will typically be about 5% - 10% of the purchase price. You could give the vendor this in cash, but it does not make any difference to him as all this money goes out of his reach into a trust account anyway. To him there should be no difference whether it is an ‘unconditional promise to pay’ cash from a reputable financial organisation or if it is cash itself.
If you supplied a bond and then defaulted on the contract the vendor would go to the bond issuer for the cash, for which he would not be refused. CGU would promptly pay him the cash, and then CGU will come looking for you to recover their money. (i.e. two very BAD looking debt collectors)
If you follow through with the purchase, settle on the property and pay the full amount on the settlement date then the bond will not have been called upon. You have met your obligations and therefore the vendor has had no right to your bond. The bond is simply returned to the issuer (CGU) and cancelled.
WHY do all this? Well, you've got $15,000 to your name and you come across (3) $300k properties at a 15% discount to the market. They will be finished in 9 months but they will be sold this week cause the deal is so good (aren't they all?).
You could put down $15k and secure one, sell it at completion and make $45k. OR you could go to CGU, pay them $4.5k and get 3 deposit bonds each for $15k. You then go out to the market and try to sell the properties at say a 5% discount (just because your such a nice guy). Anyway you sell them all just before completion and make a $30k on each. All up you put down $4.5k and you made $90k. By the way, the full amount of $4.5k is tax deductible, while the other method using the $15k cash deposit, is not tax deductible.
It's all about leverage. They allow you to keep your money in your bank for as long as possible, and that must be a good thing. They also allow you to play around in the Big End of town even though you don’t have the money to do so. You have to be using highly charged strategies for you to have the need for deposit bonds. Umm……. Strategies, there’s a good discussion topic.