What Is a Surety Bond? | SmartAsset

If you’re a business owner moving into an office that’s being renovated or you’re looking to have construction work done, you might want to consider a surety bond. It’s a contract that ensures that projects are completed and expectations are met. Not to be confused with other types of bonds, surety bonds are about transferring risk from one party to another, not earning money.

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What You Should Know About Surety Bonds

When you have a surety bond, you have an agreement in place between three different groups or individuals. Let’s say that you’re an entrepreneur who hires a contractor to build you a brand new space for your employees because you’ve outgrown your old facility. In this example, the entrepreneur plays the role of the obligee, or the person or group who wants a service or project done. The contractor is the principal, or the party that is agreeing to finish a specific project on certain terms. If there’s a surety bond, there is also a third group involved called the surety. This could be an insurance company, financial institution or agency that assumes the risk and promises to pay the obligee (the entrepreneur in this case) in the event that the contractor or the principal fails to do what is expected.

Although the principal (the contractor in our example) pays for the bond, the obligee starts the process by applying for one. Surety bonds are commonly used in construction projects, but they are also used in other situations like making sure that elected public officials meet certain requirements, or for protecting individuals in court. Whether you’ll need a surety bond depends on your situation.

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Types of Surety Bonds

Surety bonds fall into two major categories: contract and commercial bonds. Contract bonds usually refer to those that are used when construction occurs, as in the example above. This category can be broken down even further into four different types of surety bonds.

Bid bonds are needed before a project even begins. Let’s refer back to our example. If the entrepreneur is struggling to pick the right contractor for her project, she can lock in her favorites by getting a bid bond. This way, whoever is chosen to work on the project has already made it clear that they want the job, can afford to complete the job and plan for it to be done correctly.

A performance bond, in essence, is the bond meant to guarantee that the project will be done the right way – or there will be financial consequences. If for one reason or another the contractor cannot complete the project (due to an injury or the contracting business going under) the bank or the insurance company that issued this bond will find someone else who can get the job done.

Two other contract bonds are payment and ancillary bonds. Payment bonds make sure that anyone else involved with the construction project (painters, plumbers, electricians, suppliers, etc.) are adequately paid for the services that they provide. An ancillary bond acts as an additional agreement to hold the contractor and the other workers accountable for fulfilling any other obligations or desires that aren’t otherwise listed as part of the work that needs to be performed. In short, this kind of bond covers anything miscellaneous, such as rules or regulations that have to be followed, or a desired timeline for completion of different steps in the project.

In addition to these types of contract bonds, there are also commercial bonds. Commercial bonds refer to any surety bonds that don’t fall under the classification of construction work. There are court bonds used in legal proceedings, public official bonds and various permit and license bonds for circumstances from ensuring that individuals obey certain laws to ensuring that clients and customers are protected.

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Applying for Surety Bonds

Securing a surety bond begins with reaching out to a broker, bank or agent who can meet your needs. Getting approved for a contract surety bond is a little more complicated than obtaining a commercial surety bond, simply because with construction projects, you’re usually risking more when it comes to cost.

Applying for a surety bond might include a credit check by an underwriter and a deeper look into your work history and your background to determine if you’re eligible for the bond. Anyone seeking a contract bond will likely not be able to get around the credit history analysis. Not having the best credit score will likely make it slightly harder – but not impossible – to obtain a surety bond.

The Takeaway

Whether you need a surety bond for your construction project or service depends on a variety of factors. In some cases, you won’t have a choice because the law (or the other party to the contract) could require you to have one. If you do have a choice, you may still want to look into a surety bond. Having one can give you peace of mind and insurance against possible problems.

Remember that surety bonds are different than other types of bonds – you won’t earn money from surety bonds. If you’re worried about the financial side of things, consider talking to a financial advisor. A matching tool like SmartAsset’s can help you find an advisor to work with to meet your needs. First you answer a series of questions about your financial situation and your goals. Then the program matches you with up to three advisors in your area. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while doing much of the hard work for you.