Understanding Surety Bonds
Understanding surety bonds is actually a quite simple process. All a surety bond does is ensure or guarantee that some party will be paid should the financial transaction fall through. A surety bond is basically a hedge against defaulting on a loan or debt which is guaranteed by a third-party bond issuer. The primary purpose of a surety bond is to protect the interest of two parties with a guarantee of loan payment. Surety bonds are used in all walks of business including but not limited to construction, shipping and automobile loans.
Consider a situation such as building a new high-rise office complex was can cost millions of dollars. Two parties enter into an agreement including the general contractor which is responsible for constructing the building and the individual or organization which will purchase the building once construction is complete. In these types of high-stakes financial endeavors which could result in millions of dollars of loss it is common for a surety bond to be issued to protect both parties. The general contractor, halfway through development, could possibly become insolvent and may not be able to complete construction at which point the purchaser may have already spent millions of dollars in land and materials but will not have a building. It's also possible that the general contractor took out a construction loan for materials and completes the building but the purchasing organization has gone out of business and now is unable to buy the building. In this situation, a surety bond could be issued to protect both parties from millions of dollars in losses should something go wrong.
A smaller scale example is that of a bail bonds company which facilitates an arrangement between a municipality and an individual. When a court issues a $10,000 bond or cash surety then a bail bonds will be the third party to help the individual fulfill the arrangement. What this means is that should the individual skip town the bail bonds company has assumed the financial risk for the individual and will be on the hook for the $10,000 should they be unable to return the individual to jail. However, if that individual upholds their part of the arrangement then the bail bond organization makes its money from the 10% or $1000 on the bond amount which the individual paid to bond out of jail in the first place.
Due to the dollar amounts, the bond issuer or underwriter will often do a thorough analysis and examination of all parties involved to ensure that the likelihood of default is at a bare minimum. This bond underwriter would prefer for 100% of transactions to go smoothly without default or other financial consequences so they can keep their percentage of the fees for the bond amount without having to pay large settlements. Surety bonds only last for the life of the agreement so once the agreement has been fulfilled the surety bond is no longer valid. A surety bond, regardless of the amount , is a serious obligation for all parties involved which is meant to protect everyone from significant financial loss.
