Surety Bonds Can Save You Money
There are numerous benefits of posting a surety bond versus a letter of credit. One huge benefit is making the most of your money through surety credit. At first glance it seems the surety bond is more expensive than an Irrevocable Letter of Credit. After reading this article, you will see that surety bonds are clearly the best choice. We will also discuss how a bond saves you money and how a bank makes money from these transactions. You will feel confident knowing that using surety credit is your better option in the long run.
How Letters of Credit Work:
An Irrevocable Letter of Credit or ILOC ensures that you are â€œgood forâ€? the amount this letter, addressed by the bank, and guarantees the holder for these certain funds. The obligee holds the letter of credit and in the event of a claim, the obligee can call on the funds held by the ILOC. The bank normally freezes assets for the amount of the letter of credit as a guarantee that the account holder actually has the cash, in case the claim is called. In simple terms, on a $50,000 ILOC, you cannot touch $50,000 of funds in your account to fully cover for the amount until the letter of credit is released.
How Do Surety Bonds Work For You?
A surety bond involves three parties. The bonding company, or surety, is the carrier of the bond. The obligee is the party requiring the bond of the principal (you). The principal is the party obtaining the bond. This three party agreement is a guarantee of performance. The principal, as opposed to the bank holding assets in an ILOC, uses the suretyâ€™s financial strength. Only in high risk situations, would a surety bond require collateral.
Absolute Costs Between Letters of Credit and Surety Bonds
Yes, there are premiums and service charges associated with surety bonds and some would argue that these costs are more expensive than a Letter of Credit. Naturally, this looks like a better choice however all things are not considered. Letâ€™s take an ILOC for $100,000 as an example. Costs are $1,000 per year or 1% of the ILOC. A surety bond rate for the same amount is one to three percent or $1,000 – $3,000 per year in a standard market. The bond is equal to, or more expensive so far, correct? The bank now freezes $100,000 in order for you to â€œmake goodâ€? in the event of a claim. The surety does not require any collateral in typical situations. If you were to choose a surety bond, you could invest the money in a money market account. If the money market account has dividend of 3% to 4%, you just made $3,000 to $4,000, not to mention the 1% cost of the ILOC.
As you can see, the surety bond is your better choice if you are qualified. The surety bond allows you to invest capital that the bank would not allow you to do. Your daily operations will run smoother with increased liquidity from surety bond placement. Although surety bonds seem more expensive at first glance, they are less expensive than an ILOC and allow you more liquidity to run your business with less worries.