Surety Bond Cost

Surety bonds are important financial instruments that act as a kind of insurance or financial guarantee. It is a facility that protects businesses from losses incurred through defaulted contracts. It is one way of dealing with risks in performing contractual obligations.

This type of bond is a three-way financial agreement that holds between the 'Principal', the 'Surety', and the 'Obligee' for the purpose of guaranteeing the execution of a contract job.

The 'Principal' is the person or organization that is performing a contractual obligation, the 'Obligee' is the organization on the receiving end of the obligation, and 'Surety' is a third-party financial institution which assures that the principal will perform the assigned task.

In event of the principal not meeting obligations of the contract, in a fixed period of time, the obligee can recover all losses using the bond. The amount of compensation paid to the obligee by surety, in case the principal does not meet the obligation, is called 'Penal Sum'. This sum is later recovered by the surety from the principal.

In return for the service of issuing the bond, the surety or financial institution is paid a premium by the principal, whose value is determined by the penal sum that may have to be paid. In Europe, surety bonds, issued by banks are called 'Bank Guarantees'.

Surety bond is a generic term used for many types of bonds. Depending on the type of obligation made mandatory and nature of contract, there are many other types of this bond.

The ones that act as this instrument include:

• Contract bond (which includes bid bond, performance bond, maintenance bond, and payment bond used mainly in the construction industry)
• Permit bond (required by government laws)
• Commercial bond (that lend credibility to businesses)
• Bail bond (used to secure release of an offender till trial)

The rates for this bond are determined by many factors associated with the nature of the contractual obligation. The surety or the financial institution that offers credibility for a contract, to an applicant, considers the degree of risk involved, when calculating the cost that it recovers, in the form of a yearly premium.

The financial record of the applicant or principal is studied and the odds against the successful completion of a contract are calculated accordingly. Higher the risk involved, higher are the bond's rates of interest.

These bonds can be classified into two categories, based on the degree of risk involved and the size of contracts. In the standard bond market, that provides these bonds to small financial institutions, the rates are 0.5% to 5% of the total cost (with excellent credit score).

Strong financial position, proven industry experience, and track record are the indicators that increase the likelihood of a surety bond being acquired by a business. A good credit score on part of the applicant definitely reduces the rates.

The cost of such a bond is directly proportional to the degree of risk involved and therefore, individuals or organizations with poor credit scores can acquire these bonds, only at a substantially higher rate.

In the high-risk bond market, the rate of interest is usually 10% of the bond amount. In very high-risk cases, the financial institution may charge an interest rate of as much as 20% of the total bond amount.

There is no way that an absolute estimate can be made about the bond cost. An estimate can be made by a financial institution, only after one submits all the details associated with the contract and financial background. An accurate estimate is not possible due to the multitude of factors involved in calculating the cost of every bond.