Have you ever wondered where your deposit actually goes when you purchase a property off the plans?
It is a question we get asked a lot and it's one that is often misunderstood by purchasers.
Before we get into the nitty-gritty of where your deposit goes, it's important to understand what a deposit is. A deposit is essentially a down payment you make to secure the property you intend to purchase.
In most cases, the deposit should be equivalent to 10% of the purchase price and is paid immediately once you confirm your contract (after your due diligence period).
A deposit can be made up of cash, equity KiwiSaver, and a first home grant (based on eligibility). For most investors, equity is the key source of deposit because this can be leveraged from their existing properties.
Generally, people draw out equity from their own home.
To work out how much equity is in your own home that can be accessed for a deposit, we need to calculate your "useable equity". The following formula is used to calculate useable equity:
(Home Value x 80%) - Mortgage = Useable Equity
As an example, let's assume an investor's own home was worth $700,000 and they have a $400,000 mortgage owing. Add those numbers into our equation:
(Home Value x 80%) - Mortgage = Useable Equity
(700,000 x 80%) - 400,000 = $160,000 in useable equity
Since investors need a 20% deposit overall, this means that in this case, the investor could purchase an investment property up to $800,000 based on their equity. The second 10% equity is not required at the time of going unconditional. This is just required as further security by the bank at the time of settlement.
Now we know what the deposit is for and how we can calculate it, but where does it go when you actually pay it?
Townhouse contracts tend to have clauses which state your deposit is lodged with the vendor’s solicitor
People often think that their deposit goes straight to the developer who would use the money to fund the build, but this isn't usually the case.
In fact, most of the time, your deposit is lodged with the vendors' solicitor in a trust account which means that the developer can't touch that money for any reason until settlement.
How does this benefit the purchaser?
Well, one of the biggest concerns for a lot of purchasers is that their deposit could be lost if the development doesn't go ahead for any reason.
Having the deposit lodged with the vendors' solicitor protects the purchaser from this risk. Even if the development was canceled for any reason, the deposit will be returned to the purchaser in full.
Some contracts even include clauses that require your deposit to be put in an interest-bearing account.
If this is the case, any interest that is accrued will follow the destination of the deposit.
In other words, if the deposit is returned to the purchaser for some reason, the purchaser will get their deposit back plus interest accrued, and if the deposit is put towards a property that settles, then the interest would be credited toward the purchase price.
However, as always, there are exceptions to the rule.
Some group home builders will actually use your deposit for the build meaning your money isn't protected in a solicitor's trust account. But, there is alternative protection.
Some group home builders will use your deposit during the build
If the deposit is lodged with the builder, an insurance policy is used to protect the purchaser from losing their money.
The insurance policy tends to be very comprehensive and protects the purchaser from:
· Loss of deposit
· Non-completion of the dwelling
· Structural defects for 10 years
· And more
In either case, the purchaser is protected from developers falling over and the risk of losing your money is mitigated.
Seeking legal advice around the deposit clause is always recommended though to make sure you thoroughly understand where your money is going and how you're protected.