What is a Deposit Bond?

Malcolm Tatum

A deposit bond is a type of document that is sometimes used instead of a cash deposit on a transaction. In a sense, the bond functions as an insurance policy for the seller. Should the buyer choose to forfeit on the transaction, the bond will pay a fixed percentage of the total purchase price to the seller. With a deposit bond, no money actually changes hands; the instrument simply serves the purpose of a cash deposit on the front end; the buyer remains responsible for tendering the entire amount due on the purchase to the seller.

Businessman with a briefcase
Businessman with a briefcase

There are several benefits associated with the use of a deposit bond. For the buyer, this approach makes it possible to forgo the cash deposit, and keep that money in some type of interest bearing account. Since the bonds can be secured with relatively little effort, this approach can sometimes expedite the progress of locking in the item for sale while the buyer finishes the process of qualifying for financing. Sellers also benefit from the use of this type of bond issue, since the bond does make it possible to collect the amount covered in the event that the buyer is unable or unwilling to complete the transaction. From this perspective, the bond helps to the time and expense that the seller had invested in the transaction up to that point.

Along with the benefits of the deposit bond, there are also a few potential drawbacks. Acceptance of this type of bond instead of a cash deposit is at the discretion of the seller. This may not always be practical. For example, if a transaction involves the purchase of real estate, the seller may prefer the cash deposit if he or she has plans on using that money to put a down payment on a different piece of real estate. In like manner, real estate agents don’t always care for the use of a deposit bond, since their commissions may be paid directly from that cash deposit.

This means that before actually securing a deposit bond for use with certain transactions, it is important to check with the seller and make sure the bond will be accepted in lieu of a cash deposit. Failure to do so may lead to situations in which the buyer is unable to redeem the bond and convert it to cash in order to pay with a cash deposit. In the interim period, the real estate or other asset involved in the transaction is still up for sale, increasing the chances of losing the claim on the asset.

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