What are pre-contract deposits?
01 March 2017
By Global Administrator
We take a look at pre-contract deposits and discover why this practice has been criticised when it comes to buying a property.
Most people are more likely to associate holding deposits with rental properties, but there are some instances where a home buyer can end up paying a deposit to the seller. This type of payment is known as a pre-contract deposit and is requested by the seller and paid via the estate agent.
The practice - which is legal, although not particularly common - has been receiving more attention recently thanks to press coverage in the Guardian and the Daily Mail as well as a change in estate agency regulation affecting the way pre-contract deposits can be charged.
What is a pre-contract deposit?
These payments, often in the region of around £1,000, are designed to limit gazumping - the practice of accepting higher offers after previously accepting an offer from another prospective buyer.
Sellers who request pre-contract deposits take their home off the market, allowing the buyer who has paid to essentially 'reserve' the property. If the sale goes through, the deposit is taken off the buyer's purchase costs. If, however, the buyer withdraws their offer without 'good reason', the deposit is paid to the seller.
The idea behind these deposits is to mark out serious buyers. Someone who is not completely committed to a property purchase is unlikely to want to spend £1,000 on something they're not necessarily going to go through with.
Pre-contract deposits become more common at times - like now - when there are more buyers than properties available. Prospective buyers are aware of the increased competition for each property and so many are willing to pay in order to secure their desired home. What's more, if demand for a property is particularly high, charging a pre-contract deposit allows agents and sellers to see which buyers are most serious.
Why has this practice been criticised?
Critics of pre-contract deposits say they are a way of estate agents making money out of buyers. Agents traditionally only act for the seller and don't take any money from property purchasers. Recent media coverage has highlighted agents pocketing deposits rather than passing them on to sellers, as well as the issue of charging pre-contract deposits as non-refundable reservation fees. The problem with this is that there are so many ways in which a property purchase can unravel that buyers are leaving themselves open to losing a large sum of money and not getting anything in return.
It seems the majority of estate agents charging buyers for deposits are stipulating that they will only be repaid in the event the property is deemed unmortgageable. So, for example, if a survey reveals that a property needs significant work done - but doesn't deem it unmortgageable - a prospective buyer who has paid a pre-contract deposit and subsequently decides to pull out of the transaction is unlikely to get their deposit money returned.
What’s changed recently?
Last October, the Property Ombudsman - one of three redress schemes in the property sector that covers 95% of estate agents - updated its code of practice with specific reference to pre-contract deposits. The old version of the code stipulated that agents must not take pre-contract deposits unless it was for the sale of a new-build. However, the October update means that agents can now take deposits from buyers if certain criteria are met.
TPO is still advising agents to avoid charging pre-contract deposits but its updated code says agents may now take deposits, providing they create a written agreement that clearly sets out the circumstances under which the money would be used towards the purchase, returned to the buyer or retained by the seller.
Below is a recent statement made by Property Ombudsman, Katrine Sporle, setting out the circumstances in which pre-contract deposits can be charged:
“In October 2016, TPO issued updated versions of all its Codes of Practice, specifically referring to the disclosure of pre-contract deposits (11a). Previously, although there was nothing in law to prevent deposits being taken, the Code only allowed pre-contract deposits to be taken for new home sales.
"The rationale was to prevent unscrupulous agents from simply demanding monies from buyers for, say, removing a house from the market. However, the TPO Code must also reflect market conditions and where there are more buyers than properties, there is a heightened risk of gazumping, more failed transactions and more buyers left significantly out of pocket.”
“A pre-contract deposit has the potential to give a buyer and a seller the confidence that the transaction is likely to complete - the potential for gazumping is significantly reduced, as is the risk of last minute price negotiations. Whilst the TPO Code still recommends that agents should avoid the practice, it was considered prudent to set out what steps they must take when they did receive an instruction from a seller to collect a deposit from a buyer.”
"If an agent is now asked to take a pre-contract deposit, the TPO Code requires them to provide a written agreement which precisely sets out the circumstances under which the monies will be used towards the purchase, returned to the buyer or retained by the seller. It is a key obligation of the Code that requires agents to ensure that both the seller and the buyer agree to the arrangement before any monies are paid.”
“The updated TPO Code still protects buyers from agents seeking to profit through demanding deposits, but now imposes significant obligations to ensure that in cases where a seller asks for a deposit, the agent deals with it transparently and fairly.”
Should you pay a pre-contract deposit to an estate agent?
It certainly is a difficult and often rather complicated situation for property buyers. First thing's first, if an estate agent asks you to pay a pre-contract deposit you need to check if they are a member of a redress scheme like the Property Ombudsman.
You'll also need to ask the agent the proposed conditions of the pre-contract deposit and make sure you're not signing up to a non-refundable reservation fee. For some buyers, if they're happy with the conditions of the agreement, they'll be willing to pay the deposit to give themselves the best possible chance of securing the home they want to purchase.
It's clear, however, that at a time when the demand for properties continues to significantly outweigh supply, buyers must be cautious about signing contracts and paying any additional fees. If you are unsure about anything that you are being asked to fill in or pay by an estate agent, the best thing to do is to get in touch with their redress scheme.
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