Surety Bond Definition
A surety bond is a three-party legally binding agreement between an obligee, a principal and a surety bonds company. It guarantees to the obligee that the principal will carry out their performance and payment obligations according to agreement. The surety bond is put in place in order to protect the public and the obligee.
Here you can find more information about the three parties involved:
The obligee is the party requiring the protection of the surety bond. Typically, the obligee is a government agency regulating the industry. For example, in the case when the bond is required in order to obtain a license or permit, the obligee is the party granting the license or permit to the principal.
The principal is the party required to obtain the bond. For example, in order to get a license or permit, often a business is required to obtain a specific type of surety bond, called a license and permit bond. The most common businesses required to get a license and permit bond are contractors, auto dealers, freight brokers, mortgage brokers and many more.
The surety (also known as the bonding company) is the party that takes the risk by backing the surety bond financially up to the full amount of the bond. It provides the financial guarantee in case the principal fails to fullfil their obligations according to agreement. In order to have this guarantee, the principal has to pay a premium to the bonding company.
How Does a Surety Bond Work?
People often mix up surety bonds and insurance, but there is a major difference between the two and how they work. Unlike insurance, which protects the party obtaining the insurance, surety bonds work to protect the party requiring the bond, as well as the public.
If, for whatever reason, a principal fails to meet their obligations and a claim is filed against the bond, the surety may need to step in and compensate the obligee up to the full amount of the surety bond. In this way, a surety bond works like a line of credit extended to the principal by the surety bond company. Once the claim has been resolved, the principal has to repay the surety for the financial support.
The guarantee extended by surety bonds depends on the type of business you have, and why your business is required to have a bond.
Surety Bond Types
There are three major types of surety bonds:
License and Permit Bonds (Commercial Bonds)
The vast majority of bonds fall into the license and permit bonds category, also known as ‘commercial bonds’. License and permit bonds are part of the licensing requirements for many businesses, such as auto dealers, freight brokers, contractors, collection agencies, mortgage brokers and telemarketers, to name a few. These bonds guarantee that the individuals or businesses abide by the rules and regulations of their business license.
In the case of a claim on a commercial bond, the surety’s coverage is related to mitigating harms that concern violations of the business license, such as fraud, misrepresentation, dishonesty and others. The most demanded commercial surety bonds are:
Auto Dealer Bonds
Auto dealer bonds guarantee that motor vehicle dealers will operate in compliance with state regulations for their dealer license. They provide protection for the state and an auto dealer’s customers.
Freight Broker Bonds
Transportation brokers need to obtain a $75,000 freight broker bond as part of the licensing process of their business. Freight broker bonds guarantee payment to motor carriers and shippers who do business with a broker.
Mortgage Broker Bonds
Mortgage brokers need to get bonded as a requirement for obtaining a business license. Mortgage broker bonds protect customers who work with brokers to obtain a mortgage.
Contract bonds guarantee that a construction project will be completed in accordance with federal and state regulations as well as the terms laid out in a construction contract. Bid, performance, payment and supply bonds all fall under the category of contract bonds.
The various contract bonds serve to protect the government (whenever it is awarding a contract) as well as parties who work with contractors, such as suppliers, laborers and subcontractors.
The most popular contract surety bonds are:
Bid bonds function as security for bids submitted by contractors on a contract. They guarantee that the bidder will execute the contract at the bid price if they are awarded the contract.
Performance bonds guarantee the proper execution of all terms and conditions of an awarded construction contract.
Supply bonds guarantee that a material supplier to a project owner will furnish supplies as contracted.
Most commonly court bonds deal with an estate or guardianship situation. These bonds typically guarantee to the court that any money involved will be used appropriately.
Surety Bond Cost
To obtain a bond, a business needs to pay a fraction of the total bond amount which is called a premium. The amount of the premium is determined on the basis of a number of factors, the most important of those being the personal credit score of the applicant.
For Example, depending on how good or bad the credit score is, commercial bond premium rates fall into two categories - standard market rates, ranging between 0.75%-2.5% of the total bond amount, and high-risk applicant rates, ranging between 2.5%-10% of the total bond amount.
For extensive information on how surety bond rates are determined, see our surety bond cost page. There you can also receive an initial estimate for the price of your own surety bond through our surety bonds calculator. You can also find the calculator in the sidebar on the right.
If you have bad credit and have been denied a surety bond, you can still obtain a surety bond through our bad credit surety bond program.
Surety Bond Claims
It is best to avoid claims on surety bonds. Occasionally, it does happen that a dispute cannot get resolved and obligees file a claim against a principal’s surety bond.
When that happens, the bond underwriter has to respond by launching a claims investigation. During the investigation, the surety reviews the contract and each side’s actions up to that point.
If it is established that the claim is legitimate, the surety will usually engage and take over the project from the principal and complete it or reimburse the obligee if it has suffered financial harms due to the principal’s actions.
How to Get Bonded
To get a quote for your surety bond, you can start your online application here. If you have any further questions, you can also call us at (866)-450-3412 to speak to one of our surety bond experts. For more information on the bonding process, and surety bond requirements, see our how to get bonded page.
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