One of the greatest innovations in the homeloan finance market has been deposit bonds.

But the bonds, which have gained credence only during the past five or six years, have already come under regulatory scrutiny.

Deposit bonds are issued for a small fee of about 1 per cent of the property price.

Issued by insurance companies, the bonds replace a typical cash deposit of 5 to 10 per cent.

Purchasers still pay the deposit at settlement but keep their cash until then.

Authorities, including the Reserve Bank of Australia (RBA), the Australian Prudential Regulation Authority and the Department of Fair Trading, are watching to determine just how big an impact deposit bonds have had on the property market.

They are also trying to ascertain whether investors have been duped into using deposit bonds to speculate on property.

"The Reserve Bank is concerned that some people may have used multiple deposit bonds to buy a number of properties," says Macquarie Bank's head of property research, Rod Cornish. "Real estate is not like the sharemarket – you can't go in and out, speculating on price rises over the short-term."

In fact, in a research paper issued last year, and again during evidence given before a parliamentary committee by the RBA governor, Ian Macfarlane, on December 6, 2002, the bank expressed concern that "virtually all of the increase in housing-loan approvals over the past year was going to investors, not to aspiring owner-occupiers".

"We fear that many investors are just assuming that things will work out, which is a very dangerous thing to do if you are making a highly leveraged investment," Macfarlane said.

The bonds are underwritten by insurance companies, such as QBE Insurance, Lumley Corp or Royal & Sun Alliance. And they are often sold through agents, known as issuers, such as Deposit Access, Shield Underwriting Agencies or United Deposit Bonds.

For the buyer, parting with a few hundred dollars instead of several thousand can be hugely attractive. But if the buyer defaults at the time of settlement, the underwriter or issuer will pay out the vendor and then pursue the buyer.

The bond applicant is legally liable to pay the deposit and sometimes more.

Investors can't just walk away if they decide not to proceed with the property purchase. Deposit bonds are also secured, sometimes against the family home.

The bond premium is based on the value of the property and the length of time to settlement.

If you are about to buy a house at auction, you might use a deposit bond to secure the property rather than liquidate other assets, such as shares and term deposits.

Or you can use a long-term deposit bond to buy an apartment "off the plan", where settlement might not occur for two years or more.

Muriel Byrne, an underwriter at Shield Underwriting, used a deposit bond to buy an investment apartment in Sydney's Potts Point in January. Byrne owns a house at suburban Greystanes and managed to find an apartment that matched her investment criteria before her finances were in place.

"The apartment was the right price and it had a sitting tenant," she says.

"It took 24 hours to get the deposit bond approved and it meant that I could secure the apartment and get my finances sorted out before settlement."

Byrne says that in the past she might have been forced to use expensive and inflexible bridging finance to secure the apartment.

Instead, she paid about $450 for a short-term deposit bond, which promised to pay the $37,000 deposit at settlement if she defaulted.

By settlement, Byrne's finances were in order and her loan for the apartment approved.

But the Reserve Bank in its research paper, Innovations in the Provision of Finance for Investor Housing, says that "developers report that deposit bonds have been used by up to 70 per cent of purchasers in some projects".

"It is estimated that they are used in about 20 per cent of Sydney residential transactions, the market where their use is most widespread," the paper says.

A confluence of factors, including low interest rates, very poor returns from equity markets and the ability to negatively gear into property, ignited the boom in property prices.

But deposit bonds may also contribute to the bust.

"The planets really came into alignment for the property sector but because of that we are now seeing an oversupply in capital cities in the apartment sector," says Commonwealth Securities' senior analyst, Craig James.

Building approvals are already on the way down.

In November, they dropped 25.6 per cent, reflecting a 12 per cent decline in private-housing approvals and a 45 per cent plunge in the medium-density, or apartment, sector.

If you have used a long-term deposit bond to buy an apartment "off the plan", you may be settling on a property in 12 to 24 months that is worth less than what you have agreed to pay for it. "If you have secured five or six deposit bonds to buy multiple 'off the plan' properties which you plan to sell in a rising market before settlement, you could be in trouble," says Denis Facer, the managing director of Validate Systems, a company established to check whether applicants have applied for more than one bond.

Issuers who subscribe to Validate will be able to log on to a secure webpage and determine whether an applicant has outstanding bonds, or has applied for a bond and been refused by another issuer.

Facer says some "get rich quick" entrepreneurs have promoted the use of multiple bonds at property seminars. The advice to prospective investors includes buying a number of bonds on the same day.

Facer says the industry lacks a national register that provides real time information on who has secured a deposit bond.

"Deposit bonds are not designed to be used in that way," Facer says. "They are meant to be used by investors who intend to settle on a property but who can't put their own cash down right then and there."

Grant Bailey, United Deposit Bonds' managing director, says: "Before we issue a deposit bond, we do all the checks that any lender would do.

"That includes determining whether the borrower is actually going to make settlement.

"When someone puts a deposit down, we need to know that they are going to complete.

"And we don't assess the value of the property on what it could sell for at the time of completion.

"Our valuations are the sale price at the time the deposit is taken."

Richard Gardner, from Deposit Access, says he has never come across any investor using multiple bonds.

"But I have turned people down if I think they can't complete," he says.

"I want to know what their credit history is. I look at their employment and savings record.

"In my case, if they can't settle, then I amliable for the deposit funds."

The issuer or the underwriter may also be liable for more than the deposit.

If an investor agrees to buy an apartment off the plan for $400,000 but defaults before settlement, the developer may sue for the deposit and any loss incurred if the price of the property has fallen.

Gardner says: "The buck stops with me. I take on that risk so I make sure people can settle."

He adds that he has had very few defaults – fewer than 0.5 per cent – and some of those defaults related to death, bankruptcy, or a developer not delivering the apartment as per the plan.

Ross Kocass, marketing manager for developer Meriton, which built 2500 apartments in Sydney last year, says his company will accept only a limited number of deposit bonds as finance in any new project.

"It varies from job to job," he says. "But if we are building a 680-apartment project, we might accept deposit bonds for 300 or less apartments.

"I have heard of 'get rich quick' seminar providers spruiking deposit bonds but we are very averse to those sort of schemes."

Long-term bonding over a one-bedroom plan

She purchased the property "off the plan" and the deposit bond was secured against her partner’s existing property.

Later she purchased a second deposit bond to buy a house in Leichhardt.

"I found a house I really liked and I went to the auction with the deposit bond," Hantes says.

"Unfortunately, I did not get that house – it sold for more than I could pay.

"But I used the same bond to buy the house I live in now." Hantes sold her investment apartment in Camperdown but says she will one day use another bond to buy herself another investment property.

"I swear by them," she says. "If I wanted to buy again, I would certainly use a deposit bond."

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