how sureties work
as noted above a surety is a guarantee or promise that assures payment through a legally binding contract under the agreement one party promises to fulfill the financial obligations if the second party the debtor fails to pay the third party the creditor the surety is the company that provides a line of credit to guarantee payment of any claim they provide a financial guarantee to the obligee that the principal will fulfill their obligations a principal s obligations could mean complying with state laws and regulations pertaining to a specific business license or meeting the terms of a construction contract an example of such a contract would be when a surety company vets and hires an administrator to handle a will or estate if the principal fails to deliver on the terms of the contract entered into with the obligee then the obligee has the right to file a claim against the bond to recover any damages or losses incurred if the claim is valid the surety company will pay reparation that cannot exceed the bond amount the underwriters will then expect the principal to reimburse them for any claims paid a surety is most common in contracts in which one party questions whether the counterparty in the contract will be able to fulfill all requirements the party may require the counterparty to come forward with a guarantor to reduce risk with the guarantor entering into a contract of suretyship this is intended to lower risk to the lender which might in turn lower interest rates for the borrower a surety can be in the form of a surety bond the claim amount in a surety is still retrieved from the principal either through collateral posted by the principal or through other means special considerationsa surety is not a bank guarantee similarly it is not an insurance policy where the surety is liable for any performance risk posed by the principal the bank guarantee is liable for the financial risk of the contracted project the payment made to the surety company is paying for the bond but the principal is still liable for the debt the surety is only required to relieve the obligee of the time and resources that will be used to recover any loss or damage from a principal surety bondsa surety bond is a legally binding contract it is used as an assurance that the issuer will pay any debts if the other party fails to do so 1 surety bonds are entered into by three parties here s how it works the principal is responsible for securing the surety bond which must abide by certain conditions including the total amount owed if the principal defaults or breaks the contract the obligee who is owed the money can file a claim seeking restitution the surety or the party issuing the bond can review the claim and make a determination if the claim is paid the surety can then seek financial compensation from the principal this includes interest and fees on top of the principal balance surety bonds can be used in a number of different circumstances the table below outlines some of the most common types of surety bonds 