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Essay: Surety Bond Definition

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  • Subject area(s): Finance essays
  • Reading time: 2 minutes
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  • Published: 24 October 2015*
  • File format: Text
  • Words: 492 (approx)
  • Number of pages: 2 (approx)

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What is a surety bond?
A surety bond is a three-sided contractual agreement guaranteeing that a business or individual will fulfill their obligations under a contract and in accordance with business regulations.
The three parties involved in the surety bond agreement are the obligee (the party requesting a surety bond), the principal (the party obtaining the bond – such as mortgage brokers, freight brokers, auto dealers or contractors) and the surety (the surety company who has the means to back the surety bond financially).
How Surety Bonds Work
Surety bonds guarantee to the obligee that if the principal should fail to perform according to contract or regulations, the bond will cover for damages and losses that the obligee may sustain.
Unlike insurance, where a loss is anticipated, surety bonds are based on the premise that a principal will fulfill their obligations and a loss will not occur. Yet, if this is not the case, the surety is there to step in and compensate the obligee. Once the surety has covered for losses it must, in turn, be indemnified by the principal for the backing it has extended. In this way, surety bonding functions like a line of credit to the principal.
This stipulation is a central point of every surety bond indemnity agreement. Yet, since claims on a bond are undesirable for everyone involved, it is most often the case that they are avoided. As an active party to the surety bond agreement, surety bond companies usually extend their support and expertise to principals and help them avoid potentially dangerous situations.
Types of Surety Bonds
Surety bonds fall into three general categories: commercial bonds, contract bonds and court bonds.
Most surety bonds are obtained are in the category of commercial bonds. These are needed for businesses in order to get a license and operate lawfully.
Contract bonds are related to the construction industry and the steps that a construction project goes through: from bid to execution and completion.
Court bonds are related to real estate or guardianship situations and the fulfilment of responsibilities as ordered by a court.
Surety Bond Cost
Surety bond cost is not fixed and varies according to bond type. To get a bond, businesses or individuals must pay what is known as a premium – a percentage of the full amount of a surety bond.
This premium is determined on the basis of numerous factors but most importantly – personal credit score. A high credit score will usually lower the premium of your surety bond, while a low credit score is often the case of a higher premium rate.
Rates for high credit score applicants range between 1%-4% and are known as standard market rates, while rates for low credit score applicants (also known as high-risk applicants) are between 5%-15%.
Make sure to visit our ‘What is a surety bond’ page for even more detailed information on what surety bonds are, how they function and how you can apply for one.

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