Why are real estate deposits required?
Although the contract law states a deposit is not required to create a binding contract as the form of consideration is satisfied by the mutual exchange of promises between the buyer and seller. It has become an industry standard to provide a deposit between 5 – 10% of the purchase price.
The deposit represents a sign of intent to purchase from the buyer, gives the buyer a vested interest in the transaction making it harder for them to walk away and pre-estimates damages if there is a breach of contract.
How are real estate deposits provided?
Your real estate deposit should be provided in the way that has been outlined in your purchase and sale contract. Usually, the contract will state the deposit is payable within 24 – 48 hours of subject removal by way of a bank draft. The contract can be written up to provide the deposit by way of certified cheque, money order, wire transfer, swift transfer, ACH transfer, etc..
It is slowly starting to become more common and adopted by more realty firms to accept electronic transfers as we continue to evolve into a more technology-based society. Electronic transfers prove to be very useful if your deposit is to be provided to an account which is far away from you. Not only is it quicker, but it will also be more cost-effective than having a bank draft couriered.
What if I don’t have access to funds for a real estate deposit?
The important word to remember here is “access.” For most Canadians, their money is tied up or locked in elsewhere. For example, most people contribute to an RRSP but tap into this fund early because of larger life expenses. When this happens so does the unexpected. This means you soon realize that you are only allowed to take out certain amounts of your RRSP, have to pay large fees to gain access to this money, it takes weeks to access and you have to pay it back within a specified time frame. Something to also keep in mind is that when you take out of your RRSP, you also have to claim this as income earned. This can result in raising your income tax payable and your MSP premiums if you get bumped into a higher tax bracket.
A more common scenario is one where someone is selling their current residence in order to purchase a new home, and all of their money is tied up in their equity. Since it is common to try to line up your purchase and sale dates as closely as possible for a smooth transition from one home to the next, this creates a conflict with the deposit. As people rely on their sale proceeds to cover the necessary closing costs of their new purchase, it becomes hard to pay for large expenses before you receive your sale proceeds. Because the deposit is to be provided around 1+ months in advance of the closing date, there becomes a gap when the deposit funds are needed but are unable to be provided.
How do I get access to funds for a real estate deposit?
There are a few ways we will be looking at obtaining a loan for a real estate deposit, but each method has its pros and cons.
Home Equity Line of Credit (HELOC) – This type of loan is a secured form of revolving credit. This product closely resembles that of a large credit card, meaning you can borrow money, pay it back and borrow again up to your credit limit. Although this is one of the more cost-effective methods, there are a few restraints to this product:
- If your home is listed for sale, the lender will be hesitant to provide a HELOC. Because you are soon to sell, the lender will look at this as too much work for a short-term loan.
- You will have to qualify under stricter loan criteria. If you have any mortgage, credit or any other form of debt, this will impact the amount you will be able to qualify for.
- An appraisal may be required. This could mean about a $400 cost to you.
- A mortgage will be registered against your property. Not only will this cost you about $1,500, but if you are in a time sensitive situation, this loan may not be able to be provided in time.
Line of Credit (LOC) – A line of credit has the same concept as a HELOC, but the main difference is that this is an unsecured loan. Since there is no security for the lender, this means there is less paperwork involved, and you can get approved faster. However, since there is no security for the lender, they will consider how eligible you are as a borrower, and this is where the restraints come in. Some things to consider about a line of credit:
- You will typically be paying a higher interest rate than a HELOC.
- It is harder to obtain since there is no physical asset this loan will be associated with.
- Your credit score needs to be quite high.
- You need to have good income levels.
- The amount you qualify for (if you qualify for) will be less than a HELOC.
Mortgage – Although this isn’t the most desired option, it still needs to be mentioned. You can always register a mortgage against your property, but some things to consider:
- Most lenders will not provide a mortgage if your home is listed for sale.
- You will have to pay for an appraisal.
- You will have to pay for legal fees and mortgage registration fees.
- Your interest rate will be higher as you will most likely have to obtain this financing from an alternative lender who is willing to lend on a listed property.
- Lender and/or broker fees could be charged.
- A prepayment penalty may be charged.
- The time frame for funding will be around 1 – 2 weeks.
Bridge loan – A bridge loan is a short-term loan that is associated with the property you are selling, but the proceeds are used towards the home you are buying. A typical use for a bridge loan is where someone is buying before they are selling, but need access to their equity before they sell to complete their purchase. Since bridge financing is usually used to provide the down payment, it may be difficult to secure a bridge loan for a smaller amount like the deposit. The reasons for this:
- Banks that offer bridge loans usually offer them as a complimentary service. Since they like the longer term loans, they use a bridge loan as a way of getting you into your new home so they can secure your mortgage. If you are not obtaining your new mortgage through a bank, there is a very little chance they will provide bridge financing.
Zack Beaumont is a registered Mortgage Broker. After attaining his Mortgage Brokers license he began working closely with a professional of over 20 years’ experience in the financial industry. Once he had a firm grasp of the Mortgage Broker’s roles and responsibilities, he embarked on solidifying his knowledge of the lender’s landscape. This is where he secured a position at First National, where he began as a mortgage funder in the residential department and was soon after promoted to a fulfillment specialist. Upon collaboration and careful research, he left First National, teamed up with likeminded individuals and launched the company Deposit Financing.