According to the Small Business Administration, the importance of surety bonds for your business is significant for any kind of contracted work involving substantial payments. Surety bonds also facilitate business contracts through a guarantee to the customer that the work will be completed.
Surety bonds can be necessary to qualify for certain types of contracts. This provides a minimal level of assurance to the customer, which is one way of getting ahead of any potential work disputes. There are some surety bonds offered through the SBA, for example. These are designed to enable more small businesses to qualify.
Surety Bond Overview
Companies are often required to maintain licenses and bonding in order to operate. There are specific procedures that must be followed to get the bond. The best way to understand how this all works is to learn about the various factors that influence the final surety bond cost.
The surety bond functions as a written agreement that offers a minimal amount of assurance to the client. It also puts pressure on the company to remain compliant with the terms of the work agreement.
The party purchasing the bond is called the principal, the entity issuing the bond is called the surety, and the party benefiting from the bond is the obligee. Surety bonds can be part of a regulatory requirement for certain types of work. These bonds are often purchased in order to meet occupational licensing regulations.
The total bond amount is simply the total amount of the bond. The bond cost, also known as the bond premium, is a percentage of this total. For example, if the bond amount is $50,000 and the bond premium is 10%, the surety bond will cost $5,000.
It’s important to know that the surety bond cost can be drastically affected by the applicant’s credit score. The difference in the actual amount will be determined by the entity issuing the surety bond, but the gap can be thousands of dollars in some cases. This is an incentive to keep your credit score high because it can really affect the out-of-pocket costs of the surety bond.
How Much Does a Surety Bond Cost?
There is no stable formula used to calculate the exact cost, so it’s important to understand all of the factors that affect the final amount.
The surety bond cost is affected by some variables, the applicant’s credit score often being the most consequential. The state where the surety bond is issued will also play a role in determining the final cost. The total amount of the surety bond will be divided by a certain percentage to arrive at the cost that must be paid. Collateral and co-signers can also affect the cost of the surety bond.
There are thousands of different kinds of surety bonds, and the pricing will depend on a variety of factors. Here are the top three factors to keep in mind:
1. The total coverage amount stated on the bond: Surety bonds can vary widely in the total amount of coverage.
2. The credit score and financial history of the applicant: There are ways to obtain a surety bond even if your credit score isn’t that great. However, the cost is typically higher for applicants with a low credit score, so this has to be calculated into the overall cost. For example, a $50,000 bond might cost someone with a high credit score only $500; the same bond could cost $2,500 for an applicant with a very low credit score.
3. The type of surety bond and the extent of the guarantee: The most common types of surety bonds include construction contracts and those for licensing requirements. However, there are many other kinds of surety bonds, and the cost is determined by the factors described previously. The amount of the bond determines the extent of the guarantee because the costs of the project could be higher or lower.
Weighing the Benefits
The proportion of the surety bond cost should be weighed in relation to the potential benefits. There are many benefits to consider from the point of view of the three parties involved in the process. The principal, surety, and obligee will benefit in different ways.
Principal: The contract negotiations or licensing process can be facilitated by the principal demonstrating that a surety bond has been purchased.
Surety: The entity issuing the surety bonds benefits from the ability to control the percentage of the bonds based on credit scores and other factors.
Obligee: The obligee is guaranteed compensation if the principal fails to fulfill their contractual obligations.
Common Types of Surety Bonds
Commercial surety bonds: These are the most commonly used bonds for various types of business permits and licensing requirements. This category includes vehicle dealers, mortgage brokers, and contractors. These surety bonds are often a requirement for conducting business.
Contract surety bonds: Bidding on specific work projects might require a contract surety bond. This is often used on construction projects in which different parties bid for the contract to build or repair a public building, for example. It’s also common in land development projects.
Court surety bonds: These bonds must comply with the orders of a court. This type of surety bond covers issues relating to estates, guardian rights, appeals, and similar court issues.
The surety bond amount is only paid in the event of a successful legal claim against the business. If a company has a contract and fails to meet the terms of the agreement, the surety bond can be used to compensate the client for the loss. The principal must repay the surety company for any valid claims against the bond. This provides an incentive to properly close the deal because of the assurance given in the event of any breach of contract by the company.