Surety Bond vs Letter of Credit

Surety bonds and letters of credit (LC) are popular types of financial guarantees. They’re both used for the same reason, to mitigate the financial risk of entering new contracts by creating accountability, establishing trust, and ensuring third parties get paid

However, while a surety bond and a letter of credit serve the same purpose, they also have several key differences. 

• Cost
• Where and how you apply
• Impact on borrowing capacity
• Claims and dispute processes
• Best use cases and industry applications

Our guide below explores all of this and more. So, whether you’re a business owner, contractor, or professional requiring licensing, you can easily determine whether a letter of credit or surety bond is best for your needs.

 

What is a Surety Bond?

A surety bond is a contractual agreement. It provides a guarantee that the person or company getting bonded will conduct business per the terms outlined in the surety bond.

All surety bonds involve three parties:

1. Principal – the individual or business that needs to get bonded.

2. Obligee – the organization or government entity requiring the bond from the Principal.

3. Surety – the surety company or surety agency that issues and financially backs the bond.

A surety bond ensures that the principal is financially liable for their actions.

 

Types of Surety Bonds

There are thousands of different bonds available in the US surety market. However, most are housed under three main types of surety bonds.

1. License and Permit Bonds – Required for professionals to obtain a license to operate legally. Example: car dealers, mortgage brokers, and freight brokers.

2. Contract Bonds – Needed to conduct work in the construction industry. Example: bid bonds, permit bonds, payment bonds, and maintenance bonds.

3. Court Bonds – Required to participate in some court proceedings. Example: serving as the fiduciary of an estate, taking guardianship of a minor, and appealing court decisions.

 

How to Get a Surety Bond

You can fill out an online application to get a surety bond quickly (often in under 24 hours). 

Once you fill out a form with basic information (contact information, bond name, bond amount), your instant free quote will arrive by email. From there, simply pay your invoice, and then we will email you a copy of the bond.

 

What is a Letter of Credit?

A Letter of Credit (LC) is a bank document that guarantees payment upon meeting specific conditions (delivery of supplies, completion of work, etc.)

The three main parties involved in an LC are:

1. Applicant – the person or business applying for the LC.

2. Beneficiary – the party that the LC guarantees is getting paid (commonly a seller, contractor, or supplier).

3. Issuing Bank – The bank that issues the LC and pays on behalf of the Applicant. Typically, it’s a bank where the Applicant already does business.

An LC requires a line of credit or funding. While it typically only covers 5% to 10% of the total project cost, it minimizes financial risk from non-payment. However, some commercial letters of credit can be used to cover the full project cost.

 

Types of Letters of Credit

There are various types of letters of credit. The four most common ones include:

1. Revocable Letter of Credit – Can be cancelled or modified without the consent of all parties.

2. Irrevocable Letter of Credit – Can not be canceled or modified without the consent of all parties involved. Most secure LC for a beneficiary.

3. Confirmed Letter of Credit – Involves a second bank. This bank guarantees that if the first bank defaults, it will pay the beneficiary.

4. Standby Letter of Credit – Acts as a backup payment method. The beneficiary can draw on this if the other party’s obligations aren’t fulfilled.

 

Key Differences and Similarities: Surety Bond vs Letter of Credit 

Feature	Surety Bond	Letter of Credit
Issuer	Surety company or surety agency	Bank
Parties Involved	Principal, Obligee, Surety	Applicant, Beneficiary, Issuing Bank
Purpose	Guarantees that the bondholder will adhere to contractual obligations.	Guarantees payment to the beneficiary.
Collateral Required?	Usually no. The cost of a surety bond is primarily based on credit score.	Yes. Banks require you to demonstrate that you have sufficient assets and liquidity to cover payments to the beneficiary. Often involves a UCC filing.
Impact on Credit Line?	No. A line of credit is not involved.	Yes. A line of credit is commonly used to fund an LC. This may lower your borrowing capacity.
Claims Process	A bond claim specialist will investigate the claim to ensure you only pay if it is valid.	Pays out the beneficiary immediately upon meeting the terms. No investigation.
Cost	Lower premiums, mainly determined by credit score. The cost of a surety bond is typically 1% - 3% of the required bond amount for those with good credit.	Higher premiums, which may include issuance fees, transaction fees, amendment fees, and negotiation fees.
Risk to Applicant	Applicant signs an indemnity agreement. They assume financial responsibility for the full amount of the bond in the event of a claim.	No indemnity risk. The bank unconditionally honors the beneficiary’s draw request.
Use Cases	For obligations involving performance or compliance, such as licensing or contract work.	Payment guarantees, particularly for international transactions, that require immediate access to funds.

 

Advantages and Disadvantages of Surety Bond and Letter of Credit

Surety Bonds

Surety bonds are advantageous when you need to expedite the process. They can be issued in as little as 24 hours, and the process can often be done entirely online. Furthermore, getting a bond will not affect your credit capacity or tie up assets.

Surety bonds are generally an affordable option, typically costing 1% - 3% of the total required bond amount. However, if a claim is made against your bond, you are required to pay the full amount of the claim. It is imperative to know how to avoid bond claims.

Letter of Credit

A letter of credit is great for new contracts and instilling trust, guaranteeing that the beneficiary is paid. They are widely available at banks and are ideal for international trade relationships. They are also great if you want to secure payment while deferring actual payment to a later date.

However, letters of credit can be complex. There are various types, and you want to ensure that you understand the agreement (amendments often cost extra). The cost for an LC, in general, tends to be a bit more complicated—including issuance fees, transaction fees, and negotiation fees.

 

Financial Factors

Financial factors to consider when choosing between a surety bond and a letter of credit include premium rates and credit impact. While a surety bond premium is based on your credit score and typically costs 1% to 3% of the total bond amount, an LC costs 0.75% to 1.5% of the transaction’s value plus fees for transactions, negotiations, and amendments. 

Furthermore, a bond will not impact your credit score or credit capacity. Contrastingly, an LC often uses a line of credit for funding, which can diminish your lending capacity. 

 

Risk Management and Financial Protection

A surety bond mitigates risk through bond claims. Say a subcontractor isn’t paid for their work. They can then make a bond claim against the contractor that hired them for what they’re owed. A surety bond does not financially protect the bondholder—it protects their subcontractors, suppliers, and clients.

A letter of credit mitigates risk through guaranteed payment. It puts either a portion or the full payment on hold at the bank. Once the work is complete, the contractor (beneficiary) can then request their payout. An LC financially protects the beneficiary. Whether that is a contractor, supplier, seller, or buyer depends on the terms of the LC.

 

How Claims Are Processed and Disputes Resolved?

Surety bond claims and disputes are processed through the surety company that issued the bond. They will investigate the claim made against you, asking for supporting documentation and ensuring you aren’t paying for false claims.  

•  If the claim is found valid, the surety initially pays it. However, you must then set up a payment plan to repay them.

Letter of Credit claims are processed through the issuing bank. They will only release payment once you provide proof that the contract terms have been met.  

• If a dispute arises, it is usually due to the presented documents not fulfilling the terms and conditions (such as shipping documents, certificates of inspection, etc.). The process will begin with negotiation. If that fails, it will then proceed to arbitration and then litigation.

 

Choosing Between a Surety Bond and a Letter of Credit

 A surety bond is best for construction projects, permits, and licensing. It allows you to meet regulations if you have a lower cash flow. Plus, it doesn’t lower your credit capacity. The cost of a surety bond is mainly based on credit score. However, even those with bad credit can get bonded in many cases.

Meanwhile, a letter of credit is best to prevent missed payments. It is ideal for international work and trade relationships. However, you often need credit access to make it work—unless you have a substantial cash flow.

 

Conclusion

Surety bonds are easier to access and require less capital. However, when you need to guarantee payment, especially in international transactions, a letter of credit is invaluable.

Both types of contracts are great for fostering trust, ensuring obligations are met, and helping your business comply with regulations. Which guarantee you choose will depend on your financial capacity and preferred risk management style.

 

Sources

JW Surety Bonds. (n.d.). How to get a surety bond. JW Surety Bonds. Retrieved June 25, 2025, from https://www.jwsuretybonds.com/edu/how-to-get-surety-bond

Corporate Finance Institute. (n.d.). Letter of credit. Corporate Finance Institute. Retrieved June 25, 2025, from https://corporatefinanceinstitute.com/resources/commercial-lending/letter-of-credit

JW Surety Bonds. (n.d.). Surety bond cost: Guide & free online quotes. JW Surety Bonds. Retrieved June 25, 2025, from https://www.jwsuretybonds.com/edu/what-do-surety-bonds-cost

JW Surety Bonds. (n.d.). What is a surety bond? JW Surety Bonds. Retrieved June 25, 2025, from https://www.jwsuretybonds.com/edu/what-is-a-surety-bond