What is a Surety Bond?
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With over 50,000 bond requirements across the U.S., getting a surety bond is a must for many professions. Therefore, knowing what a surety bond is, when you need one, and how to get one is essential.
In short, surety bonds are required to legally work in various industries or partake in certain court proceedings. You can think of this bond as a line of credit that you need but hope never to use.
The information below dives deeper into surety bonds, including who needs them, common types available, the bonding process, and an example of how a surety bond works in a real-life situation.
Don't have the time to read about surety bonds below? Watch our quick 90-second video which covers how surety bonds work.
You can also take a look at our most frequently asked surety bond questions.
Surety Bond Definition
A surety bond guarantees the completion of a task or obligation. Each one includes a legally binding contract between three parties: the principal, the obligee and the surety.
If the principal fails to complete the task or obligation, the obligee can file a claim against the bond for damages. If a claim is deemed valid, the surety reimburses the obligee.
Any claims must be repaid by the principal to the surety—as outlined in the indemnity agreement that every bond holder must sign.
An indemnity agreement, also known as a general agreement of indemnity, includes your business and all owners. Indemnity agreements pledge your corporate and personal assets to reimburse the surety for any claim(s) and legal costs that may arise.
Read our guide to learn more about how indemnity agreements work.
What is a Surety Bond Used For?
A surety bond's primary purpose is to protect government entities and the general public from financial loss and other losses. If the bond's requirements are not met, such as not performing contracted work or failing to pay suppliers, vendors, or subcontractors, a claim may be filed against the bond.
"What's a Surety Bond?" Infographic
What Does a Surety Bond Guarantee?
What a bond guarantees varies based on the type of bond and the specific language of the bond form. However, there are two general guarantees attached to every surety bond.
A surety bond is a financial guarantee for the government and general public that you will conduct yourself per the terms outlined in the bond contract. However, the surety company backing your bond is also guaranteeing you are in a strong enough financial position to cover any claims that may arise. If the surety is wrong and payment cannot be collected from you directly or through the courts, they are ultimately responsible for the costs.
For this reason, bonds are underwritten based on the potential of a principal causing a claim, as well as the ability of the principal to repay a claim in the future.
How Does a Surety Bond Work?
Surety bonds are a liability and work as a form of credit (with the exception of fidelity bonds).
If the bond's requirements are not met, such as not performing contracted work or failing to pay suppliers or vendors, a claim may be filed against the bond. Whether claims or made by the public or the obligee, they must be repaid by the principal to the surety.
Do I Need a Surety Bond?
You only need a surety bond if you're being required to obtain one, which you will be notified of depending on the circumstance. There are thousands of surety bond requirements across the U.S. for varying reasons and occupations.
What Bond Do I Need?
The obligee requiring your bond will have the information regarding which type of bond you need and the bond amount.
Obtaining the Right Bond
It can be challenging to know which type of bond you need, but you can take these steps to ensure you're getting the right bond:
- Contact your state or local licensing authority or the obligee requesting the bond to ask which category of bond you need, and in what amount
- Use our bond analysis tool for free to determine which bond you need
- Contact us directly for assistance with figuring out your specific bond needs
Additionally, it may be beneficial to review common bond types and what they guarantee, such as bonds required in California, Florida , and Texas. You can see all surety bond requirements by state here.
It is also helpful to understand the various bond categories, as we laid out above. Some common surety bonds required for licensing include auto dealer bonds, contractor license bonds, and freight broker bonds. Look at the full list of license and permit bonds here for more specific information.
Which Industries Require Surety Bonds?
Surety bonds are required by a number of industries and professions across the U.S. This includes, but isn't limited to:
- Auto dealers
- Mortgage brokers
- Notary publics
- Collection agencies
- Health clubs
- Travel agencies
- Freight Brokers
Types of Surety Bonds
In general, three categories of surety bonds exist that may be required as part of doing business. These broad surety bond types include:
- License and permit bonds - these types of bonds are required for various professionals to operate legally. Auto dealers, licensed contractors, and freight brokers are some examples of professionals required to secure a license or permit bond.
- Contractor bonds - individuals or businesses working on public construction projects and government contracts are likely required to obtain a contractor bond. This includes construction bonds, bid bonds, and maintenance bonds.
- Court bonds - certain courts require these bonds for various purposes, such as probate or judicial bonds.
Who is Involved in Surety Bonds?
There are three parties involved in a surety bond:
- The principal: whoever needs to obtain the bond.
- The obligee: the one requiring the principal to get the bond.
- The surety: the insurance company or surety company guaranteeing the principal can fulfill the obligation.
Who Can Issue Surety Bonds?
Qualified insurance companies and surety bond providers can both issue surety bonds. However, bonding companies are often advantageous with lower rates and better support.
If a claim is made against your bond, a company specializing in surety bonds is more knowledgeable and practiced in the process. They can answer your questions and guide you through the claim investigation with ease.
For more information, read our article "How to Choose a Bonding Company?”.
Who Does a Surety Bond Protect?
A surety bond protects the obligee and the general public.
Surety bonds being commonly referred to as a “type of insurance” has led to much confusion regarding what a surety bond is and who it protects. However, being bonded works differently than being insured.
How to Get a Surety Bond
Fill out our online application form to obtain a free bond quote. Our quotes are no obligation, take 5 minutes, and you will be able to lock your rate for the next 90 days (in case you want to purchase the bond).
How Does the Surety Bonding Process Work?
Bonding is generally an easy process with a handful of simple steps. Here is what you can expect from the bonding process.
- Fill out a bond application for our in-house underwriters to assess.
- Once your bond is approved, you will get a quote and an indemnity agreement.
- Sign the agreement and email or fax it back to your bond provider.
- Pay the invoice online.
You will receive a copy of the surety bond in an email once everything is processed. Additionally, the original bond will be sent to you in the mail.
How Long Does It Take to Get a Surety Bond?
When you go with an experienced surety company, bonding is a quick and painless process that can be done in as little as a day or two. Larger bonds and payment and performance bonds often require a little extra processing time.
How Much Does a Surety Bond Cost?
A surety bond costs generally 1-10% of the full bond amount. So, for example, if you need a $20,000 bond, your costs could be anywhere between $200 - $2,000.
Bond cost varies drastically depending on the bond amount you need and your rate. Your rate is determined by an underwriting process. An underwriter will look at your financial statements, credit score, and past bonds to determine your financial strength.
Have bad credit? It's still possible to get a surety bond with bad credit, but its premium will likely increase.
You can use our bond premium calculator to get an instant estimate. If you need to get a firm surety bond quote, you can apply to get an online approval.
Surety Bond Benefits
From a principal standpoint, surety bonds are often used for their advantages over bond alternatives. Some obligees allow you to post cash instead of a bond, often in the form of a single lump-sum payment to a custodian or trustee that is on hold to cover claims. In other cases, a letter of credit may be posted instead of a surety bond.
However, surety bonds have many advantages over these bond alternatives, including:
- Non-Asset Collateral - The surety provides the guarantee for you, so you don't have to use your assets to make the guarantee. For example, if you have a claim to pay and you used a mortgage to pay the up-front cost, the financial institution uses your home as collateral if you cannot pay through other means. Surety bonds can help you avoid these asset seizing situations.
- Lower Costs - Although you save the expense of the bond premium when you use an alternative, you face other challenges. For instance, you could lose investment earnings, even from a relatively conservative portfolio, by posting cash as your bond. In most cases, this is a bigger financial burden than paying the cost of a surety bond.
- Increased Capital - Posting your own assets, including cash, in lieu of purchasing a bond decreases your liquidity. This can make it more difficult to get financing or cover major expenses in the future. Also, lower capital reserves could lead to your company defaulting on a contract or going bankrupt.
- Claim Investigation - A surety works through an investigation process when a claim against a bond is made. This is not often the case when you post assets or cash to cover an obligee's requirement. You could inadvertently pay for claims that are not valid when using an alternative to a bond because you do not have claims advocates on your side.
Surety Bond Example
Here's a quick example of what a surety bond is used for in the case of contractors.
Need for a Bond
Let's say a business owner (the principal) has just moved to Georgia and wants to start a small business in the construction industry. He decides he wants to be a general contractor. However, the State of Georgia (the obligee) dictates that you need a general contractor license to take on construction contracts over $2,500. There are many requirements to obtain this license, and one is a $25,000 contractor surety bond that acts as a financial guarantee.
Applying for a Bond
The business owner applies for a bond through a surety company (the surety). A quick underwriting process assesses how much of a risk he is by looking at factors like his credit score, financial statements, previous bond history, and moral character. This business owner is an excellent candidate and secures a surety bond premium of 2%, meaning he pays a flat fee of $500.00 to obtain the bond from the lender.
Claim Against a Bond
The business owner’s application is a success. They now have a General Contractor Limited Tier License, which means he can take on work with a contract price of up to $1,000,000. Fast-forward half a year later, and it is found that his workmanship on a residential home is faulty. It isn't the standard agreed upon in the contract between him and the project owner. The project owner puts in a claim against the bond. The investigation finds that the business owner failed to uphold their contractual obligations, so the surety pays out to the project owner. The business owner is now on the hook for paying back the surety.
History of Surety Bonds
The first known use of the term “surety bond” traces back over a century (1911). However, the concept of surety bonds goes back much further.
In 2,750 BC, a surety contract between two farmers was written on a Mesopotamian tablet. The agreement outlined that Farmer 1 would take on Farmer 2’s fields after he got drafted into the King’s army. Profits were agreed to be split evenly. A merchant signed as a surety, guaranteeing that Farmer 1 would uphold his end of the agreement.
Fast-forward to 1840, when the first successful corporate surety was founded, Guaranty Society of London. Many followed, such as the Fidelity Insurance Company in 1865. Which, according to The New York Times, was the first corporate surety company in the U.S.
The Consumer's Guide to Surety Bonds E-Book
If you want the most thorough answers available to all of the fundamental questions related to securing a surety bond, download our free "Consumer's Guide to Surety Bonds" e-book. Topics covered in the e-book include:
- How surety bonds work
- How indemnity agreements affect you
- The various surety bond types required
- Surety bond pricing
- How to get bonded
- How claims affect you
This e-book was designed to educate consumers, specifically first-time applicants. It is an excellent resource if you are unfamiliar with how surety bonds work, the pricing of surety bonds, or how bonds affect you or your business.
All You Need To Know About Surety Bonds!