property buyers guide to Contract Deposits
Buying a home or a property investment would be so simple
if you did not need to come up with the deposit and wait
forever for unconditional loan approval before signing a
In this article, we look at why a deposit is necessary
and the rules that apply to its payment. Then we look at how
to use Cooling Off Periods to tie up a property until the
loan approval comes through.
Why is a 10% deposit required
for a property purchase contract?
The Law is that a deposit is a guarantee (the law
calls it an earnest) given by the purchaser when the
contract is negotiated that they will perform the contract.
As Lord Justice Fry said in 1884 when deciding the case
of Howe v Smith - The practice of giving something to
signify the conclusion of the contract, sometimes a sum of
money, sometimes a ring or other object, to be repaid or
redelivered on the completion of the contract, appears to be
one of great antiquity and very general prevalence.
The deposit paid under a purchase contract is applied
against the purchase price when the contract is
completed or is kept by the vendor if the purchaser
The courts refer to it as the customary 10% deposit
in a property purchase contract.
Why is it not a 5% or 20% deposit?
The reason is that the courts consider 10% of the price
to be a reasonable amount that a vendor can keep (the legal
term is to forfeit) if the purchaser fails to
complete the contract.
Therefore, a 10% deposit is a benchmark requirement for
Is it possible to pay less
than a 10% deposit?
The answer is yes, if the vendor agrees.
Vendors often agree to a 5% deposit payable on the
signing of the contract, if the sale is by auction. They
agree so as to attract potential purchasers who have sold
their property but have not yet settled the sale or who
cannot access the deposit paid under their sale contract.
If so, an additional clause is inserted into the contract
which makes the 10% deposit payable by two instalments: 5%
payable on the entry of the contract, and 5% payable on
A 5% deposit is not so common for private treaty sales.
When it is agreed, the deposit is often released to the
vendor on the entry of the contract, as a quid pro quo for
agreeing to a 5% deposit.
What ways are there to fund
Deposits can be saved or sourced.
Funding the deposit for a first home or first property
investment is the hardest because it must be saved. A useful
guide to saving is to use the home loan repayments at 2%
above the current interest rate on a loan amount sufficient
for the property you are looking to buy, add rates and
insurance, then deduct the rent you are paying. If (for
example) the surplus is $300 per week, then the deposit will
be saved at the rate of $15,600 per year.
Funding the deposit when trading up to a new home is
easier because a deposit guarantee bond can be purchased and
used as the 10% deposit. The current home is the security.
The purchaser hands over the deposit guarantee bond to ‘pay’
the deposit. Not all vendors will agree to a deposit
guarantee bond because although it is equivalent to cash, it
is not cash.
Funding the deposit when buying an investment property is
easy – borrow against the equity in an existing property. If
the property is owner occupied, you need to avoid the tax
trap of simply increasing the current loan. You need to take
out an investment loan, separate from the current property
loan, to ensure that the interest will be tax deductible.
Increasing the current home loan will risk ‘muddying the
waters’ because interest on the home loan is not tax
Are there creative ways to
fund a deposit?
There are many creative ways to fund a deposit. Some are
practical, others are difficult.
One way is to use a delayed settlement contract.
To illustrate, the deposit might be paid in
instalments over a period of 3 months or longer, with the
purchaser permitted to take possession paying rent (the
legal term is possession under licence).
Another illustration of a delayed settlement
contract is where a landlord agrees to sell the house to the
tenant. The rent continues to be paid, but landlord agrees
to accept the deposit instalments – if the instalments are
$300 per week above the rent, then tenant will be paying
$15,600 per year towards the deposit. This is called Rent
to Own, which is a form of vendor finance. It works
provided that the tenant is assessed to be creditworthy by a
mortgage broker to take out a loan once the deposit has been
paid, and the amounts payable are affordable within
responsible credit guidelines.
Parents regularly fund deposits for their children to buy
a home. If so, the parents need to decide whether to make it
a gift or a loan. If it is a loan –
- it is usually interest free because adding interest
creates a tax problem for the parents;
- it should be properly documented and secured by a
registered Caveat over the property; and
- it is repayable on the sale of the property. Usually
there are no regular loan repayments.
What happens to the deposit
after it is paid?
Normally, the deposit is paid into the trust account of
the vendor’s real estate agent or the vendor’s solicitor. It
is held by them as ‘depositholder’ or ‘stakeholder’ until
the contract is completed. On completion, along with the
balance price, the purchaser hands over an ‘order on the
agent’ which authorises the depositholder to release / pay
the deposit to the vendor.
What is the legal status of the deposit pending
completion of the contract? It is held by the depositholder
for both vendor and purchaser until the contract is
completed or terminated.
- If the purchaser does not complete the contract,
then the vendor can terminate the contract and obtain a
court order to pay it the deposit.
- If the vendor cannot convey the title because they
are bankrupt, cannot remove a caveat or discharge a
mortgage, or cannot remedy a defect in title, then the
purchaser can terminate the contract and obtain a court
order to pay it the deposit.
If the deposit paid is a significant amount, some
vendor’s agents will invest the deposit and divide the
interest equally between the vendor and purchaser.