A surety bond is used to guarantee the work of a project or obligations of a contract. It’s often used by contractors as well as with business-to-business transactions. Businesses are “bonded” with this agreement, which involves three parties: the principal (business), the surety (financial institution), and the obligee (customer).
The costs of surety bonds range widely depending on the type of surety bond, location, the industry, risk of the bond, and the amount of coverage needed, as well as other factors. If you are a business owner, understand when surety bonds are required and how the cost can vary. That way, you know what to expect when you apply.
- A surety bond is an agreement between three parties often used in contract work to guarantee the obligations of a project, ensuring the project will be completed.
- The cost of a surety bond, also referred to as surety bond premium or surety bond rate, can vary between 1% and 15% depending on your industry, amount of work to be covered, and the risk involved.
- Surety bonds may be required for public officials, contractors working in construction, and professionals in specialized roles.
What Is a Surety Bond?
A surety bond guarantees the work when contractors or businesses come into agreement about specific tasks and projects through a contract. This ensures the work will either be completed or the customer who paid for the work will be compensated if obligations are not met.
The surety bond consists of an agreement between three parties:
- The principal: the business completing the work or obligations set in a contract and must purchase the bond
- The obligee: the party that requires the bond
- The surety company: the financial institution providing the bond to guarantee the principal’s obligations
These bonds are often a requirement for those working in certain industries, such as contractors in construction, public officials, and professionals who specialize in their line of work and must meet regulations to perform work.
When Do You Need a Surety Bond?
Two of the most common types of surety bonds are commercial bonds and contract bonds.
Commercial bonds are required by laws and regulations for businesses in specific industries to perform their work. They include payment bonds, bid bonds, performance bonds, and fidelity bonds. Contract bonds, which are required by the government or construction projects, include license and permit bonds, and public official bonds.
Payment bonds are used to ensure third parties and contractors, such as suppliers and laborers, receive the agreed-upon pay.
Bid bonds provide a guarantee if the bidder does not enter into contract or if the bidder fails to provide a surety bond.
A performance bond is used to guarantee the obligations included within a contract, such as terms and conditions.
Businesses can receive protection from fraud and other related activity caused by employees through fidelity bonds, which act as an insurance policy.
License and Permits Bonds
Businesses within certain specialized industries or professional roles, such as a plumber or electrician, may require a license and permit bond to run the business due to regulations.
Public Official Bonds
Public official bonds are required for some public office holders, such as those handling public funds, to ensure their duties are performed faithfully.
There are many other reasons surety bonds may be required. Other common types of surety bonds include:
- Court bonds
- Notary bonds
- Tax bonds
- Performance bonds
- Utility bonds
- Business services bonds
- Other miscellaneous bonds
How Much Does a Surety Bond Cost?
The cost, or premium, of a surety bond ranges, depending on the type of surety bond required, your line of work, the risk involved, what the bond is intended to cover, and the credit score of the principal.
Surety bond costs, also referred to as premiums or rates, also differ depending on location as the requirements are set by state and local agencies. Typically, a down payment is also required.
In general, surety bond rates can cost between 1% and 15% of the amount of the bond, with some slightly lower than 1%.
Generally, the higher your credit score, the lower your rate. Surety companies and insurance companies offering surety bonds can give you a quote so you can see where you stand financially.
Rates can also be lower depending on your industry. For example, construction bonds, which include payment bonds and performance bonds, are generally lower, from 0.5% to 3%. Court bonds range from 0.5% to 1%, and some license and permit bonds can range from 1% to 5%.
You may find lower rates if your business qualifies through a program. For example, payment bonds and performance bonds guaranteed by the U.S. Small Business Administration only cost 0.6% of the contract price.
There may be other costs involved in the form of reimbursement if the work was not completed as agreed within the contract. If a file is claimed, the principal may be required to reimburse the surety if it is determined that the principal did not comply with the contract.
How To Get a Surety Bond
Depending on the type of bond you need, there may be different requirements to obtain the bond. There are a few general steps businesses can take when applying for a surety bond.
Understand Bond Requirements
Whether you are just starting your business or you’re considering contract projects, you’ll need to know if certain bonds are required in your industry.
Agencies at the state, city, and county levels set regulations for requirements to run a business or have contracts approved, so conduct research for your specific location. Once you figure out the requirements, you can conduct research to find the right surety.
Determine Qualifications and Gather Documents
Most surety bonds focus on credit score and personal finances of the principal, so it’s important to check your credit history if you are going to apply for a surety bond. You’ll need to gather documents to provide proof of your financial standing, and may need documents to show details about the project as well.
Follow Guidelines Specific to Your Location
Regulations for surety bonds for businesses and individuals are determined by state agencies, as well as cities and counties. Each may have separate requirements, such as providing certain documentation. Follow the requirements specific to the type of bond you need as directed by your local agencies, then contact a surety to apply.
Applying for a Surety Bond
Finally, you will submit your financial documents to prove your credit worthiness and ability to meet the bond’s terms along with documents regarding the details of the project that the bond will cover. These documents will be reviewed by the financial institution. If you’re approved, the surety bond will be issued to you for your signature and the obligee’s signature.
Frequently Asked Questions (FAQs)
Who issues surety bonds?
A surety bond is issued by the surety, or surety company, which guarantees the work or obligations in the contract. This can be an insurance company that offers surety bonds, or a company that specializes in providing surety bonds. For example, a surety company issues a bond to the principal, the business or contractor who is to complete the work, when it is required by the obligee.
How are surety bonds different from insurance?
Surety bonds differ from insurance because they are made to provide protection to the obligee, the party requiring the bond. Insurance provides protection directly to the policyholder, generally covering a broad area and protecting the business rather than a specific project and the obligee.
What is the most common type of surety bond?
Common types of surety bonds include license and permit bonds, which are considered a type of commercial bond. These bonds are used by both businesses and individuals, and provide professionals with the required licenses for their industries.