Risk mitigation is a major concern for owners of construction projects. Surety bond and letter of credit are the two primary tools used to manage risks in the construction industry.
Put simply, surety bonds and letter of credit give security to the state or private owners that contractors will fulfill their obligations and finish projects on time. However, a surety bond is a much better option than a letter of credit. Read on to find out why:
Surety Bond Vs. Letter of Credit: Know The Difference
Also known as LOC, a letter of credit is issued by a bank. It’s a guarantee that the contractor will perform all the obligations stated in the construction contract.
On the other hand, a surety bond is a written agreement between the obligee (the construction project owner requiring the bond); the principal (the contractor buying the bond) and the surety company (the party selling the bond).
Similar to a letter of credit, a surety bond is a guarantee that the contractor will fulfill their responsibilities or tasks, as per the terms and conditions of the contract. If they fail to do so, the surety company will intervene and pay the obligee the bond amount for the losses incurred. The principal will need to reimburse the surety agency later.
A bank may freeze a buyer’s (contractor in this case) liquid assets in the total amount of the letter of credit. If the buyer fails to fulfill their obligations to the beneficiary (the principal) of the letter of credit, the beneficiary can cash in the letter to secure funds on demand. On the other hand, surety bonds cannot be obtained on-demand. The surety agency determines the validity of the claim, while the principal files the claim.
Why A Surety Bond Is Better than A Letter of Credit
- With a surety bond, you won’t have to worry about your liquid assets being freezed. Unlike a letter of credit, surety bonds can free up your cash that is held by your bank (as security).
- You can use the cash to reinvest in the growth of your company.
- As letters of credit are issued under a company’s credit facility, a surety bond allows you to use the credit for other business needs.
- As surety bonds are not included on an applicant’s financial statements, they can help you secure credit in future. Letter of credit does impact an applicant’s financial statements.
- Surety bond rates are usually less than letter of credit rates. In case of letter of credit, banks tend to charge hidden fees.
Searching for a surety bond agency near you? BondPro offers a range of surety bonds across all 50 states in the U.S.
Contact us to learn more.