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.

What is a Surety Bond?
This type of bond is a three way, financial agreement that holds between the 'Principal', the 'Surety' and the 'Obligee' for 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 that assures 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. The many types of bonds that act as surety bonds include the 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) and a bail bond (used to secure release of an offender till trial). Depending on the type of obligation made mandatory and nature of contract, there are many other types of surety bonds.

Factors Affecting Surety Bond Cost
The surety bond rates 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.

Cost Estimate
Surety 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 1% to 4% of the total cost. 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 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 can range from 10% to as much as 15% 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 the calculating the cost of every bond.