In business and government, accountability is key to getting anything accomplished. That's why there are surety bonds. These bonds help ensure that contracts and services go off as expected and provide solutions if they don't. Read on to learn more about these versatile instruments.
What is a surety bond?
What is a surety bond?
A surety bond is a type of bond that is often required for contracts. These bonds can ensure that certain things happen, whether as a promise from a contractor or as a way to pay for damages when they don't. For example, if a government contractor is building a new courthouse and disappears halfway through the construction, their surety bond will guarantee that the city has the funds to pay someone to complete the work.
There are different types of surety bonds with different goals. Surety bonds are not to be confused with investment-grade bonds, which allow you to earn interest by loaning some amount of money to a government entity or corporation. With a surety bond, the only party making money is the one that writes the surety bond, and they do so at considerable risk.
Types of surety bonds
Types of surety bonds
There are two main categories of surety bonds: contract and commercial. Contract surety bonds are required of a contractor, often one who bids on government or commercial construction projects. Commercial surety bonds, on the other hand, protect a wide range of interests and include those you must get to be "bonded" at your job.
Here are some common types of surety bonds:
Contract surety bonds
- Bid bonds.
- Performance bonds.
- Payment bonds.
Commercial surety bonds
- License bonds.
- Permit bonds.
- Judicial bonds.
- Fiduciary bonds.
- Public official bonds.
- Notary bonds.
- Miscellaneous bonds.
Benefits
Benefits of surety bonds
Surety bonds are a way of ensuring that your interests are protected, whether as part of a construction contract or as part of official duties as a notary. The bond is similar to insurance in that if something goes wrong, it can be activated to help cover damages. Unlike insurance, the expenses that those surety bonds cover ultimately fall back on the shoulders of the principal.
In the case of most surety bonds, the person holding the bond -- known as the principal -- is the person who needs protecting. Going back to the notary, for example, if they were to notarize something and make a mistake that resulted in damages to another party, their bond would help shield them from financial harm. In the case of a building contractor who has to get a surety bond for a government job, the surety bond protects them in case something happens to make completing the job impossible, but it also protects the government entity in that it will pay for what hasn't been finished.
Related investing topics
Why they matter
Why surety bonds matter to investors
Surety bonds don't seem like the kinds of things that should matter to investors at all, but especially in the case of contract surety bonds, they can make a huge difference. Imagine, if you will, that you're buying municipal bonds for a bridge project in your city, and a company is hired to do the engineering and construction. This is a huge project, and there's a lot of money on the line -- including money that you've loaned to the project with hopes of returning some interest at the end.
If the bridge builders fail to meet their agreed-upon terms, the bridge project could have serious cost overruns that ultimately eat up more money than there is for the project, dooming it to either never being completed, or to bankrupting the project entirely, as well as your hopes of a return on your investment.
So, if you're investing in things like bridges and aqueducts, it's not a bad idea to ensure that your project requires surety bonds before you fork over your hard-earned money. It's one more way to safeguard your future and the future of projects that you believe in enough to buy their bonds.
