It often seems that our credit score has come to be only trustworthy measure of our financial reliability, so much so that it determines the most important aspects of our lives. When we buy a home or a car, even when we apply for a job, credit score has a big say in the final outcome. Being a sort of a financial guarantee, surety bonds are also heavily affected by credit scores.
Why does credit score affect surety bonds cost?
It’s simple. Every surety bond is a three-party agreement between an obligee (the one requiring the bond), a principal (the one paying for the bond) and the surety (the one backing the agreement). In case of a breach of agreement, the wronged party can file a claim against the principal’s bond. If the claim is deemed valid, the principal and the surety have a legal obligation to repay the estimated losses. Naturally, sureties don’t want to lose money and assume a 0% loss ratio when underwriting each bond. Therefore, people with a bad credit score are considered riskier partners and are subject to slightly different conditions.
What constitutes bad credit?
Credit scores go on a range between 300 (lowest possible) and 850 (highest possible). Typically, credit scores below 650 are considered unfavorable, whereas anything above 750 is considered excellent. A low credit score places you in a high-risk market where surety bonds prices are costlier. A surety bonds price is typically a percentage (premium) of the total bond amount that you pay on an annual basis. Standard market premiums vary between 1% – 5% of the amount of the bond, whereas high-risk applicants can be asked to pay anywhere between 5% and 15%, sometimes going as high as 20%. On occasion, they may require collateral as an extra precaution. A bad credit score can even cause your application to be declined.
A low credit score is not the only factor that can make you a high-risk applicant. Other conditions such as civil judgments, unpaid debts, tax liens or bankruptcies can also negatively affect your bond price. On the plus side, if you have strong financial statements and many years of expertise in your business field, these can partially offset the negative effect of the aforementioned factors.
It is important to note that surety bonds prices are calculated on a case-by-case basis. Moreover, each of the three type of surety bonds is differently affected by bad credit. The price of license bonds (also known as commercial bonds) is heavily affected by personal credit score, but denials are rare. 98% of high-risk applicants get an approval. The only two cases in which people get rejected is if they have open bankruptcies (closed ones are okay) or late child support payments. Court bonds prices, on the other hand, are much less affected by bad credit scores, but joint control with a lawyer can often be cited as a condition for bonding. Finally, high risk applicants cannot qualify for contract bonds (such as bid, performance and payment bonds).
How is credit score calculated?
There are a few different versions of the credit score. The version I quoted above is called FICO score, named after the Fair Isaac Company that came up with it. It’s the version you will most frequently encounter.
While there’s no precise formula for determining your credit score, it is known that it’s the sum of a few factors – payment history, amount of debt, length of credit history, inquiries and mix of credit. Payment history and amount of debt account for more than half (about 65%) of your credit score, while the rest is taken by length of credit history (15%) and inquiries and mix of credit (each accounting for 10% of the score).
Finally, there couldn’t be more straightforward advice than to pay your bills and pay them on time to avoid any future complications. As mentioned earlier, our credit score defines us in the face of all financial institutions that seem to run our lives one way or another. So be careful and good luck.