With surety bonds, collateral is typically used for protecting the surety bond company from a possible loss. Here, you can learn about the collateral used for surety bonds, along with some pros and cons of each.
Keep in mind, while there are thousands of surety bond types, the most common include court bonds, licensing bonds, and construction bonds. Each one has unique characteristics regarding the collateral requirements. There are some bonds that require full collateral, but most allow some discretion regarding collateral and what is required.
Conventional Surety Bond Collateral
Some of the most common types of surety bond collateral are listed here.
ILOC – Irrevocable Letter of Credit
ILOC are the most common type of collateral taken by a bond company. The ILOC is a letter that’s written by a financial institution that guarantees the obligation of the bond. The financial institution that issues the letter is letting the surety bond company know they are backing the principal for the bond.
From the point of view of the surety bond company, the ILOC is a trusted source of collateral and is easily convertible to cash if needed. To receive an ILOC, the customer has to have a strong relationship with their bank or financial institution to even qualify. It’s important to note the average person may have difficulties getting the ILOC because most financial situations want to have 100 percent certainty, which can often be problematic.
Cash collateral is another common type of collateral used for surety bonds. Usually, the principal will wire transfer funds from their bank account to the collateral account held by the surety bond company. In other cases, the customer writes a cashier’s check to the company providing the surety bond.
One downside of using cash for collateral is that customers lose the “opportunity cost” of using the funds for another purpose.
Often, if collateral is required, they need the use of their cash. The biggest benefit of cash collateral is that it’s simple and fast to understand by all the parties involved. Cash is also the most secure type of collateral used.
Even though this is riskier, some surety bond companies will allow you to use estate as collateral. The surety bond company puts a lien on the real estate until the bond is finished. After being exonerated, the surety bond companies file the “Full Reconveyance,” which dissolves the lien.
There are some risks associated as using real estate for collateral purposes. For example, who is the true owner of the property? What’s the property’s value? How much equity is in the property being used? Is the property part of a trust?
There are some great benefits of real estate however. For one, it does drain the company’s cash and banking resources. It’s also cost effective if its free of debt. Finally, it can be done quickly and easily without the involvement of other parties.
The answers to these questions (and others) will determine if it is possible to use real estate for collateral purposes.
Other Types of Collateral
The options listed here are the most common types of collateral used for surety bond. Some of the other options include:
- Brokerage accounts
- Job profits in the right circumstances
In the surety bond realm, the most common form of collateral that’s used is an ILOC because its cost effective and widely used. If you want to use another one of the options listed here, your situation is going to be evaluated based on your specific situation.
To speak with a surety bond expert, contact MG Surety today!