10 Things to Know before Buying a Surety Bond

Surety bonds are required in many industries, including construction, real estate, and finance. For first-time bond buyers, the process of obtaining a surety bond can be confusing and overwhelming. The goal of this article is to demystify the process and provide a clear understanding of what a surety bond is, why it is needed, and the factors that can influence the cost of obtaining one. By the end of this article, first-time bond buyers should feel confident in their ability to navigate the surety bond buying process and obtain the bond they need.

1. What is a surety bond?

A surety bond is a three-party agreement between a principal (the business or individual buying the bond), an obligee (the government organization or regulating body requiring the bond), and a surety (issuer of the bond). Surety bonds financially guarantee that the principal will fulfill their obligations to the obligee and if they do not, the surety will step in to provide compensation. If you want an in-depth explanation, check out our ‘What is a surety bond’ guide

For example, California contractors , (the principal), are required by the California State Licensing Board (CSLB), (the obligee) to obtain a $25,000 contractor bond as part of their licensing requirement to operate in the state. To satisfy this requirement, contractors get their bonds from surety companies, the surety. If a licensed contractor violates the operating agreement set out by the CSLB (i.e. if they do  not completing a job that they received payment for), then the surety company will compensate the affected party (the contractor’s client) for their financial loss. The surety company will then seek financial repayment from the contractor. 

2. Surety and insurance protect different things

Surety and insurance both offer financial protections against risk, but they differ in who they are meant to protect.

Buying a surety bond is like having someone promise to pay a third party if you don't fulfill your contractual obligations with the third party. For example, if you sign a contract to finish a construction project, you can get a surety bond that promises to pay the client if you don't finish the project as agreed. If you don’t do your job, then the surety company that sold you that bond will pay the client. Ultimately, however, the surety company will try to recover losses from you. You are not off the hook. The surety bond exists to protect the third party, not the principal of the policy

Insurance is like buying protection against something bad happening to you. For example, if you buy car insurance, you pay a certain amount of premium  to the insurance company in exchange for damages to your car in case of accidents. Clearly, insurance is to protect the principal of the policy. 

So, the main difference between surety and insurance is that surety is a promise that someone else will pay a third party if you don't fulfill your promise, while insurance is protection against damage to you as the principal

3. Surety bonds ultimately lead to a better outcome for contractors and consumers

Apart from regulatory compliance, surety bonds also help foster trust between consumers and businesses. In 2022, the Surety and Fidelity Association of America (SFAA) conducted a study “The Economic Value of Surety Bonds” and found that bonded contractor projects were 2.5 times to 10 times more likely to be completed compared to unbonded projects. The study also found that customers were 5x more likely to believe that their contractor would finish the job on time or ahead of schedule if the contractor was bonded vs. unbonded. 

Not only are surety bonds great for consumers, they are also beneficial for businesses. The same study surveyed 100 construction project owners and found that 97% of them expressed a willingness to pay higher costs for bonded contractors. Breaking down that 97% further, 50% were willing to pay an extra 1%-4% of the construction project and 47% were willing to pay an additional 5%-9% of the construction project! 

4. Credit score is by far the most important factor for price

The price of a surety bond depends on several factors, such as the bond type, the financial health of the applicant’s business, and the bond amount. However, the most significant factor is the principal's credit score. Surety companies use credit scores to gauge how likely an applicant will default on their bond if a claim were to happen. The higher likelihood of default, the higher the price. In some cases, a surety company may even refuse to provide a bond if an applicant’s credit score is too low. 

Here's a table illustrating the typical relationship between credit score, the type of bond and the percentage of the bond amount that needs to be paid as a premium. For example, if you have a 700 credit score, and wish to purchase a $50,000 auto dealer bond, then the price range you can expect is $250 - $750, which is 0.5% and 1.5% of $50,000 respectively.

Credit Score Auto Dealer Bond Freight Broker Bond
700 0.5%-1.5 1%-2.5
650-699 0.5%-2.5 3.5%-4.5
600-649 2.5%-4.5 7.5%-10
550-599 4.5%-7.5 10%-12
Under 549 7.5%-10 12%-15

*Note here that freight broker bonds are one of the riskiest surety bonds out there, with the highest cost. Most bonds are more similar to auto dealer bonds in terms of price. We’ve chosen to showcase the high percentage cost of freight broker bonds to illustrate how bond type can impact the price of a bond. 

For applicants with poor credit scores (usually below 579 according to FICO), there is still hope. We understand that not everyone has a perfect financial history, and we partner with adverse market carriers that specialize in providing surety bonds to those with less-than-ideal credit scores. These carriers offer a range of bond solutions, albeit at higher premiums, to help businesses meet their bonding requirements.

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5. You can have a cosigner

This is a lesser known fact when it comes to surety, but it’s actually possible to have a co-signer on a surety bond. This can be super useful in situations where an individual’s credit score is lower 

If an applicant has a poor credit history or limited financial resources, a cosigner with good credit and financial stability can help convince the surety company that the applicant is worth taking a risk on. In the case of multiple cosigners, a surety company will consider an application using a combined credit score of the co-signers. For example, if John had a credit score of 600 and he applied for a contractor bond with his wife Jane, who has a credit score of 700, then the surety company will assess their bond application at a credit score of (700 +600) / 2 = 650. This would result in a better price compared to if John had applied for the bond on his own. 

However, it's important to note that being a cosigner on a surety bond comes with its own set of risks. If the principal fails to fulfill their obligations and the bond is paid out, the cosigner will be responsible for repaying the full amount of the bond. This can have serious financial consequences, so it's important for a cosigner to carefully consider the risks before agreeing to cosign a surety bond.

6. Surety prices vary greatly. So make sure to shop around

In our experience, surety bond prices from carriers vary widely, depending on the bond and carrier. Therefore, it’s important for you as an applicant to shop around and ask for a few quotes before purchasing. The reason for this is because different carriers specialize in different bonds and different segments. For example, for the California contractor license bond, we’ve found that CNA Surety has the best prices for applicants between 600 and 650, whereas Hudson Surety has the best prices for applicants above 650. 

At SuretyNow, we’ve put in a lot of work to figure out which carrier has the best prices for which bond at which credit score range. We also look for quotes from 10+ surety carriers before sending you the most affordable quotes if you bond with us, you can be rest assured with the most affordable price in the market . If you find a better quote from another company, let us know and we’ll match it. We keep our cost low so we can provide you with the most affordable bond. 

7. Bonds need to be kept up to date 

Bonds need to be kept up to date for compliance reasons. Here is a list of the most common changes to a business that also need to be updated for a bond:

  • Business name
  • DBA name
  • Business address
  • Coverage amount (can be either due to regulatory changes or change in business) 
  • Ownership structure (if provided when purchasing bond) 

Changes are made via a bond rider form that needs to be officially filed with the surety company. Some brokers take care of this, some do not. If you bond with us and need this change to be made, give us an email or call and we’ll take care of it. 

8. Financing is available 

Yes, financing is often available for surety bonds, but they often cost extra. Many bonding companies offer financing options to make it easier for individuals or businesses to obtain the bond they need. Financing options usually take the form of instalment payment plans, which allow the bond premium to be paid in multiple payments over a set period of time. For example, one of our carriers offers a $50,000 California auto dealer bond at an annual price of $375, or a monthly price of $38 (comes out to $456 annually). 

Financing options for surety bonds may vary depending on the bonding company and the type of bond needed. Some factors that may affect financing options include the amount of the bond, the creditworthiness of the principal and the cosigner (if applicable), and the purpose of the bond. Generally, surety bonds are not that expensive relative to insurance, so we recommend that customers purchase bonds up front. However, if you require financing, send us an email and we’ll check to see what financing options are available for you. 

9. Successful claims on surety bonds need to be paid back

Here’s another important distinction between surety bonds and insurance. If a claim is made on your bond and the surety company deems that the claim is valid, they will pay out the claim first, but then seek repayment from you, the principal. The amount to be repaid includes not only the claim amount, but also any fees or costs associated with validating the claim. 

For example, if a California contractor fails to complete a job that causes damage of $30,000, the customer can make a claim on the contractor’s surety bond. The surety company that issued the bond would look into the claim, and let’s say that they deem it valid. The surety company would then pay out $25,000 to the customer, since $25,000 is the bond amount for a CA contractor bond. Remember, the maximum amount that will be paid out to claims is the bond amount that was purchased. In this case, the customer gets paid the maximum amount ($25,000) but it doesn’t fully cover their losses ($30,000). The surety company would then seek repayment from the contractor ($25,000), plus any costs associated with investigating the claim. If the contractor chooses not to repay the surety company, the surety company will cancel the contractor’s bond, and the contractor will lose their license. 

10. Surety bonds are tax-deductible (for businesses)

In some cases, the premium paid for a surety bond may be tax-deductible. This largely depends on if the surety bond was purchased for business purposes, such as to obtain a license or permit, or to guarantee performance of a contract. For such purposes, the premium can be deemed a business expense and is tax deductible. However, if the bond is required for personal purposes, such as to secure a bail bond, then the premium is not tax-deductible.

It's important to note that the rules regarding tax deductions for surety bonds can be complex, and may vary depending on the specific situation. It's always a good idea to consult with a tax professional to determine whether a surety bond premium is tax-deductible in a particular situation.