A Surety Bond is a contract between three parties: a professional surety agent, a pre-qualified contractor (principal), and a project owner (obligee), which binds the contractor to fulfill the terms and conditions of the contract. If the project isn’t completed successfully, the surety assumes the contractor’s obligations and ensures that the project is completed.
A surety is a way to protect yourself legally from a financial loss. They are very common in the construction industry, and are also used by notary publics, auto dealers, mortgage brokers, and insurance agents, among others.
What Surety Bond Insurance Is Not
A surety bond isn’t a loan or a line of credit extended to contractors. Rather, it’s a guarantee that the surety agent will fulfill the terms of the contract between the contractor and the project owner should the contractor fail to do so. Therefore, surety agents carefully select which contractors they will cover, and may be reluctant to take on new contractors or those with poor performance.
Technically, surety bonds are not the same thing as insurance. Insurance tends to protect against something bad happening, whereas surety bonds operate with the assumption that nothing bad will happen.
Things to Think About
The first thing to consider is whether or not the government requires a surety bond. This is often the case for major construction projects and public works projects over $100,000. State requirements may vary.
You’ll also want to assess how much financial risk is involved if the project isn’t completed properly or on time. Surety costs (penalties) tend to range from 1 to 3% of the total contract amount, although very large projects may cost less than 1% of the total.