What are Bonds and Why Do You Need One?

What are Bonds and Why Do You Need One?

March 01, 2022

Surety Bond

“A surety bond is a form of insurance protection that is essentially a promise by one party to be liable for the debt, default, or failure of another party”. It is a three party contract where one party guarantees the obligation or performance of second party to third party. In other words, it is binding between two parties that one party will give performance to the other party. It is the promise to be liable for debt, default or failure of the other. It is legal agreement between three parties. The working of surety bond is explained here

Principal: Principal is the first party. Principal is the business or individual which promised to give the performance. Principal pays for the surety bond.

Oblige: Oblige is the second party. The performance is promised for the oblige. Oblige bears the loss if the performance is not delivered.

Surety: it is the third party. This party gives compensation to the oblige if principal fails to deliver the performance.

Surety bond is the guarantee, which gives compensation to the oblige if principal company fails to deliver the performance or act according to the agreement.

There are three main categories of surety bonds. These categories are given here

  • Commercial Surety Bonds
  • Contract Surety Bonds
  • Court Surety Bonds

Commercial Surety Bonds: commercial surety bonds are used in business practices. These bonds are used to refrain business to indulge in fraud practices and make sure transactions and performances between businesses. These bonds are commonly used by state, federation, local governments, ordinances, vendors and businesses. Utility bonds, license bonds are the types of commercial bonds.

Contract Surety Bonds: contract surety bonds are used between the entities to ensure that contracts are completed according to the requirements. These bonds are used in construction industry where various complex practices are involved. Bid bond, performance bond and payment bond are the types of contract bonds.

Court Surety Bonds: court surety bonds are used by a person who pursuing action through court of law to avoid any financial loss. These bonds ensure the fulfillment of court appointed tasks. Judiciary bonds are the type of court surety bonds.

Mortgage Bonds

Mortgage bonds are secured by a mortgage which are backed by real estate property or real estate holdings. In the mortgage bonds, principal have claim over the rea estate asset of the oblige. Banks usually use mortgage bonds. The lender can sell the real estate to get the interest until the payment is returned. The investment of the principal is secured through the mortgage bond as the security is real estate. The holder of mortgage bonds can sell the real estate in order to pay the dividend and compensate the default.
Mortgage bonds are different from other bonds. In case of mortgage bonds, interest may fluctuate depending on various factors. Where, in case of traditional bonds, rate of interest is fixed.

There are the following types of mortgage bonds

  • Pass through
  • Collateralized mortgage obligations

Court Bonds

Court bonds are the security when an action to be taken through a court of law. These are the court ordered bonds. Following are the types of court bonds

Appeal Bonds: when financial judgment is made court and appeal is placed then court will order an appeal bonds to protect the original judgment. These bonds are issues to give guarantee to the awarded party is appeal is lost to stop appellants from wasting time of court

Injunction Bonds: this bond is used by the court to stop other from action in question.

Custodial Bonds: these bonds are given by the guardian of the asset that they will use the assets for the best of the minor or incapable. These bonds protect the assets of the minors, when someone else has the authority over their assets.

Probate Bonds: probate bonds are given by the one who is given the responsibility to distribute the asset of other one. These bonds protect the estate’s assets from misuse.

Lottery Bonds

Lottery bonds are issued by the government. These bonds give a chance to the buyer to win the monthly drawing in order to get tax free prize. There are the interest free bonds. But, the allow an opportunity of saving for the investors.

Lottery bonds are a type of government bond in which a portion of the bonds issued is redeemed at a price higher than the value of the bond. Lottery bonuses look like standard fixed rate bonds. They have an expiration date, which is usually quite long, and they pay regular interest or coupons. Individual bonds are numbered within each issue in the same way as traditional bonds, but the serial numbers serve a different purpose. The lottery voucher serial number gives the buyer an additional incentive to purchase the voucher. Although the details vary from bond to bond and issuer to issuer, it remains essentially the same. Drawings are carried out according to a schedule to determine which serial numbers will be redeemed. The issuer then repurchases the individual bonds within the issue identified by the draw, reducing the total cost of issuance over time and redeeming more bonds. Only a small percentage of the bonds are redeemed for more than their value. As a result, the holder of this particular bond will have won the "lottery". Savings accounts linked to prizes are like lottery bonuses.

Contract Bonds

Contract bond is the surety that the guaranteed contract will be fulfilled. These bonds are used in the construction bonds. Some of the contract bonds are

Bid bond: in the procurement or construction, one company bids its prices for the contract. This bond is used to protect the bid for a specific period of time. This will not allow the bidding party to exit the contract.

Performance Security: performance security bond binds the oblige to give the performance according to the contract

Payment security: payment security ensures that the employer will give payment to the contractor, if the contract is carried out according to the contract.