Bond insurance is a form of financial guarantee that increases the credit rating of a debt instrument. It’s most commonly seen among municipal bonds and asset-backed securities.
Three parties are bonded: the obligee, the principal, and the surety. This differs from an insurance policy, where only one party is protected – the insured.
What is a Bond?
Bonds are financial instruments that provide a cash flow stream and are backed by the issuer’s creditworthiness. Like stocks, bonds are rated by rating agencies.
There are many different types of bonds and multiple scenarios where a business might need one. For example, public official bonds guarantee that an elected official or person who handles money faithfully performs their duties. Contract and fidelity bonds guarantee fulfillment of contractual obligations such as payment of subcontractors.
Three participants in a bond are the obligee, the principal, and the insurance company that backs the bond. The insurance company makes a profit by charging the principal a premium for the bond. The insurance company expects the principal to repay them if they incur a loss. If the principal does not fulfill their contractual obligation, the insurance company will file a claim against them with the obligee to recover the loss.
Bond insurance is designed to provide an additional layer of security to bondholders. In the event of a bond issuer’s default, the bond insurance company guarantees the payment of principal and interest to bondholders as scheduled.
What is a Surety Bond?
A surety bond is a three-party contract between a contractor or business, known as the principal, and a government organization or business that requires an assurance that the work outlined in a contract or permit will be finished within a specific time frame and following local laws. The agency that requires the bond is called an obligee. If the work isn’t done according to the bond terms, the obligee can file a claim against the bond with the surety company.
The surety company investigates the claim before deciding whether to pay it. The bonded contractor must reimburse the surety company if the claim is paid. Unlike insurance, which requires the principal to put up assets that can be directly accessed in the event of a claim, getting a bond allows the principal to avoid putting up any assets and keep them free for other uses. This also gives the principal a competitive edge over companies that don’t have a surety bond.
What is a Guarantor?
Guarantors agree to be responsible for a loan or lease obligation if the borrower fails to meet their financial commitment. The guarantor must have good credit, substantial income, and sufficient assets to satisfy the obligation. They do not, however, have any ownership rights in the property being guaranteed.
For example, a student applying for their first apartment after graduation may need a guarantor to get approved. The landlord would prefer to have a guarantor on the application, especially if the student still needs a prior rental or credit history.
A guarantor is different from a co-signer, who is also responsible for the rent but does not live at the location. Co-signers are often spouses or roommates, whereas guarantors are typically parents or other family members who can be trusted to pay the rent in an emergency. Guarantors are frequently used, especially in markets for homes that are competitive. However, people who agree to be a guarantor should understand the responsibility and consequences before signing.
What is a Credit Check?
A lender will analyze your credit history as part of a credit check from one of the leading credit reporting agencies. This report lists all your credit accounts, such as loans, lines of credit, and mortgages, and shows how you’ve used those accounts. The credit report also includes court records such as bankruptcies, payment defaults, and County Court Judgements (CCJs). Lenders often conduct a credit check before approving new credit products like loans or mortgages. Since research has shown that persons with solid credit scores tend to make less claims, insurance firms may also perform a credit check to help determine premiums.
A credit check that doesn’t impact your credit score is called a “soft inquiry” or a “soft pull.” Common examples of soft inquiries include employers running a background check on potential employees, companies extending preapproved credit offers, and current creditors conducting periodic account reviews.
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