We have had many people asking us this question and I thought I’d go back to the first book I’ve written: “how to buy unlimited properties” and get this info for you from page 133 to 139. Happy reading
After we signed the sale contracts, we needed to pay deposits. A deposit is usually 10 percent of the purchase price. The primary purpose of a deposit is to provide a consideration to make the sale contract binding. The deposit also shows you are a genuine buyer. Most importantly, if you are in breach of the sale contract, your deposit will be paid to the vendor.
In my experience, very few purchasers question the amount of the deposit, or request a smaller deposit than the usual ten percent. When a purchaser has requested a smaller deposit, though, I have rarely known a vendor to refuse.
You don’t have to pay a 10 percent deposit
The deposit the purchaser pays is held in a trust account, either by the vendor’s estate agent or solicitor. In most cases the vendor will not receive this money until the property has settled, at which time they will receive the full proceeds from the sale. So, it does not usually matter whether the purchaser pays a smaller deposit, as long as it is enough to compensate the vendor if the contract is breached.
With the six townhouses, and all of my purchases since then, I requested a smaller deposit. I waited until the price had been agreed upon, because requesting a smaller deposit at the beginning may have looked like we could not afford to buy the properties.
When an estate agent asks me why I will not pay a 10 percent deposit, I tell them the deposit I am proposing is sufficient to demonstrate that I am a genuine buyer and to be adequate security for the vendor. I also tell them I cannot pay the deposit in cash. Instead, I provide a bank guarantee or deposit bond.
How guarantees and bonds work
I used guarantees and bonds when I bought my first investment properties. At the time I really could not afford a 5 percent deposit, let alone a 10 percent deposit, and I could not afford to lose a deposit of any size.
A bank guarantee or deposit bond can be used to buy a home instead of cash. A guarantee and a bond are essentially the same in what they provide. Both guarantee that if a purchaser is in breach of the sale contract, the company who issued the guarantee or bond will pay the agreed deposit to the vendor in full.
Of course, if this happens the company providing the guarantee will then seek reimbursement from the purchaser.
While the function of these instruments is essentially the same, the way in which they are issued is very different. To get a bank guarantee you must prove that you are able to settle the property, and only banks issue them. Deposit bonds are not issued by banks and you do not have to prove that you can settle the property. Instead, you must show that you have assets worth five times the value of the bond.
Guarantees and bonds are wonderful tools, designed specifically for people who are asset rich but cash poor. They are ideal for people who have money in their own home, the share market, term deposits and the like.
Guarantees and bonds are not free and the cost, like the application criteria, varies greatly between companies. Numerous companies now provide these types of deposits. The cost depends on the size of the deposit and the length of time before the property is settled, and the guarantee or bond can be terminated.
Generally, I have found bank guarantees cheaper than deposit bonds, but harder to obtain. Although the cost for this type of deposit can seem expensive, it is usually not much more than you would pay if you borrowed the deposit money (taking into account the interest that would be charged and the establishment costs for a loan).
A deposit paid in cash earns no interest, sitting in a solicitor’s or estate agent’s trust account waiting for settlement.
Getting our guarantors
Because we could not prove to the bank that we could settle the townhouses, we had to use deposit bonds. Each of us needed assets worth five times the value of the bond, which we did not have.
The answer was to find people with assets who would be prepared to be our guarantors. This means if the deposit bond was paid to the vendor because we were in breach of the sale contract, the company who issued the bond could secure the assets of the guarantor to ensure that they could retrieve their money.
We approached family and friends. Not surprisingly, we met a lot of trepidation, but in the end our parents agreed to guarantee us. To prove that their homes (which were used to secure our bonds) were safe, we provided personal agreements. These allowed our parents to secure any of our assets to meet any financial obligations relating to the bonds.
This personal agreement may seem like little comfort, because we did not have the assets to secure the deposit bonds by ourselves. But it gave our parents enough confidence to be our guarantors.
The vendor is only entitled to the deposit
If a purchaser is in breach of a sale contract, the vendor is only entitled to receive the agreed deposit stated in the contract. So, for a $400,000 property with a 5 percent deposit ($20,000), you will need assets worth $100,000 to get a deposit bond. How- ever, if the purchaser breaches the sale contract the vendor will still only receive $20,000. The company that issued the bond will seize assets worth $20,000 belonging to the purchaser (or guarantor). Purchasers must show assets worth five times the amount of the bond because:
- some assets are easier to liquidate than others (for instance term deposits are easier to liquidate than shares, and shares are easier than real estate),
- the value of the assets may decrease after the bond is issued
- some assets may be disposed of after the bond is issued.
Even though our assets were not enough to fully reimburse our parents if the deposit was paid to the vendor, we did have some of the deposit and we would repay any shortfall until the debt was repaid in full.
Gratitude is good business practice
We also paid our parents a small fee for agreeing to let us use their homes (their only major asset) as security for our bonds. Although this money was unsought, we wanted to further demonstrate our belief that their homes would be safe, and we wanted to show our own commitment and professionalism.
As children, we constantly take from our parents without much thought to the sacrifices they make. We have often received unconditional gifts and blessings from our parents with little thought or recognition.
We did not want our parents to think of us as ungrateful children they were propping up. Instead, we wanted to be viewed as professional investors who genuinely believed in what we were doing. Although the amount we paid was not large, it was enough to show that we appreciated that they were showing faith in us by letting us use the home they worked hard to pay off over the last 20–25 years.
The money we paid to our parents, together with the solicitor-approved personal agreement, didn’t just reassure our parents about their homes. It also showed that we were taking a professional approach to our investment portfolio.
To demonstrate our thoroughness, I showed our parents the comparable sales and other research we had collected relating to the townhouses. I then went through the negotiation process with them. Finally, I showed them my financial report for my inner-city apartment, to give them an idea of the work we were still going to do to ensure that we could settle the properties. I explained the entire process so that they would feel comfortable.
Ex gratia payments to family or friends may seem like a lot of money when added to the cost of deposit bonds or insurance, but the amount you pay family or friends is up to you. It is most important not to lose sight of your ultimate goal.
In this instance, we were each buying a townhouse for over $400,000. Without our parents’ help, we would still be dreaming about our first investment property. The amount we paid for a bond plus the payment to our parents was insignificant compared to what we could make in the long term.
Our syndicate agreed it would be better to pay a nominal amount for a deposit bond and a nominal amount to our parents than to save that money and go without an investment property.
This proved to be one of the best decisions we made.
Since bank guarantees and deposit bonds have become widely available, it has become much easier for people to use the equity in one property to buy another property. Once you have a property it is relatively easy to get a bond or guarantee for another property. With every new property you buy the next property becomes easier to secure.
How to build a portfolio without spending your own money
If you are able to buy a property for the right price, you use a guarantee or bond for the deposit, and you borrow the remaining funds, it is possible to buy a property using very little of your own money. This is how many astute investors buy more and more investment properties without touching money in their private savings accounts.
Although I needed my parents’ assistance for my first two investment properties, the equity in those two properties was enough to get my next bond, which secured the next investment property. Now the equity from every new property I buy helps me get the bond and bank finance for my next investment property.
- A deposit smaller than 10 percent is fine, as long as it is big enough for the vendor’s security
- Bank guarantees require proof you can settle. Deposit bonds require assets five times the bond’s value
- Treat your guarantors with professional courtesy and plan for disaster
- Once you own a property, you can use the equity to buy your next