When you need to guarantee a payment or performance, you have two options: a cash bond or a surety bond.
Which one is right for you depends on a few factors. For instance, you might have the cash on hand to post a bond, but what if you need that money for other things? That's where a surety bond comes in.
Alternatively, you may have a reserve of cash that you're able to use in exchange for a lower bond fee.
In many industries, such as construction industries, surety bonds are required for project bidding and licensing, so it's important to understand how they work.
In this blog post, we will explain what is the difference between a cash and surety bond and help you decide the best option for your needs.
What is a Surety Bond?
A surety bond is a three-party agreement between you (the principal), the surety company that backs the bond, and the obligee/owner. The surety company agrees to pay the obligee if you fail to meet your obligations.
The benefit of a surety bond is that you don't need to have cash on hand to cover the full value of the bond. You can purchase the bond for a fee and only need to come up with the full amount if you fail to meet your obligations.
What is a Cash Bond?
A cash bond is when you post cash in order to fulfill your obligations. The advantage to the principal of a cash bond is a lower fee. Because reserves are essentially covered by the cash on hand, there is no need for funds to be readily available. The disadvantage is having to have the full bond amount in cash on hand.
What is the Difference Between a Cash and Surety Bond?
The main difference between a cash bond and a surety bond is the number of parties involved. Cash bonds only involve two parties, you and the owner. In a surety bond, there is a third party, the surety company.
The term surety refers to any party that guarantees the payment of a debt or performance of a contract. A financial institution, surety company, or underwriter is only one example of a surety. Any person or firm that is putting up the money or collateral on behalf of the principal is eligible to be a surety.
In a surety bond, the surety company is taking on the risk, so they will charge a fee for this service. The advantage of a surety bond is that it does not require you to have the full amount of money on hand. The disadvantage is that you will be required to pay a premium, which acts like an insurance policy from the bond company.
Example of Cash Bonds vs. Surety Bonds
Let's say Construction Company ABC put in a cash bid of $150,000 for a project that begins on June 1st. In the bid specs, it stipulates that ABC must give at least a 10% bid on the $150,000 project.
So ABC heads to the bank and withdraws $15,000 for the bid, using a certified check. The funds are then debited from their account.
ABC is not the only bidder on the market, but they do come in second. The bid specs specified the bid was to be valid for 60 days, meaning ABC cannot retrieve its check until at least August 1st.
Now, that $15,000 is completely tied up and unavailable for the firm to use. They will not be able to invest this money nor earn interest on the principal during this time.
On the other hand, Construction Company XYZ has decided to use a surety bid bond when bidding on the same project.
The surety (through a World Insurance Surety professional) agrees to financially back the principal.The World Surety professional executes a bid bond in the amount of 10% of the bid project. The consruction company retains its cash position and only pays a bond premium if the contractor is awarded the project.
What Happens Next?
The bid bond stays in effect for the required 60 days. In that time, XYZ is able to continue investing cash into its business, while ABC is down $15,0000.
Construction Company ABC has not yet been bonded by a surety company because the cash bond has not yet qualified them. They do not know whether they will be able to get a Performance and Payment bond or what it will cost. On the other hand, Construction Company XYZ has been pre-approved and pricing has been determined.
Choosing Between Cash and Surety Bonds
Now that we understand how bid and cash bonds work, it's time to learn how to choose between the two.
A cash bond is just what it sounds like—a construction company posts cash as collateral to back up its bid. The full amount of the bid is held in escrow until the project is complete. If everything goes smoothly, the money is released back to the contractor. If there are problems with the project, the money can be used to cover damages or other expenses.
A surety bond is a bit more complicated. The contractor does not post cash as collateral. Instead, they work with a surety company that agrees to back the bid.
Risks in Cash Bonds vs. Surety Bonds
There are a few key differences between cash and surety bonds. First, with a cash bond, the entire amount of the bid is at risk if something goes wrong. With a surety bond, only a portion of the bid is at risk. Second, getting a surety bond usually requires some upfront paperwork and may take a few days. With a cash bond, the contractor can simply post the money. In most cases, contractors will need to get a surety bond in order to bid on projects. However, there are some instances where a cash bond may be required. For example, if the contractor is bidding on a very small project, the owner may require a cash bond instead of a surety bond.
If you're not sure which type of bond is required for your project, be sure to ask the owner or contact your World Insurance Surety professional for more information.
Choose World Insurance Surety Bond Professionals
Surety bonds are a common requirement in many industries, especially construction, where there is a higher risk of default. In large construction projects, owners will typically require a surety bond in order to protect themselves from financial loss in the event that the contractor fails to complete the project.
A cash bond, on the other hand, is simply a deposit of money that is held by the owner in order to ensure that the contractor completes the project. If the contractor does not finish the project, the owner will keep the money.
While both cash bonds and surety bonds can protect the owner from financial loss, there are some key differences between the two types of bonds. Surety bonds are typically more expensive than cash bonds, but they offer more protection. In addition, surety bonds are backed by an insurance company, which means that the owner does not have to worry about losing money if the contractor fails to complete the project.
If you're in need of a surety bond, be sure to choose a reputable company like World Insurance Associates LLC. We have over 20 years of experience and can help you find the right type of bond for your needs.
Learn more about our surety bond products today!
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