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It's not really a loophole.
When the rules talk about not being able to use it for your 'deposit' they mean you can't use it for the deposit that you have to give the seller at exchange of contracts. Because at that point you are not buying a property, you are just committing to buy a property subject to the completion terms which won't happen until later. The HTB bonus can only be used for paying for the property on a successful completion.
In this case, the seller decided they were happy to accept a low deposit at the time of exchange, to help you out. So they took 4% up front at exchange and 96% at completion, and you funded the 96% with a 95% mortgage and a 1% HTB bonus.
When the seller agrees to accept a small deposit at the time of exchange (4% instead of 5% or 10%) he is taking a risk that you might fail to complete, and not actually go through with the purchase, leaving him high and dry without much cash in his bank, and needing to sue you for his costs and the problems you cause him. Sometimes, sellers can be in the mood to take a gamble and let you get away with a relatively tiny exchange deposit to help you out. So, you got away with it and he still got paid the 100% in the end, just getting his money later than he was planning
If anyone else was looking to rely on being able to do what you did, they would be well advised to agree it with the seller very early on. For example if you were giving them £12.5k deposit and they were part of a chain and needed to give £25k to the person they were buying from, exchanging contracts on the same day, and then you said you could only made a deposit of £10k after all, they may not have the luxury of being able to say, ok, just give me a lower deposit and we'll exchange anyway. Because the next person in the chain that *they* are buying from, might not budge on the deposit they want to receive, and your seller in the middle doesn't want to take the difference out of his own pocket and have a cashflow problem and bigger risk.
The industry standard deposit at exchange is 10%. If you're buying with a 95% mortgage you are probably on the small end of the scale in terms of transaction size and deposit size so a seller may be able to afford to let you do just a 5% deposit instead of 10%. But getting the exchange deposit down further - to 4% because you screwed up the HTB ISA mechanics - is not something anyone should be banking on.
Originally posted by bowlhead99
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Alright fella, chill out, I'm just telling people of my experience.