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What Are Surety Contracts?

A surety contract is a legally binding agreement in which the signee will accept responsibility for another individual's contractual obligations. This is often a loan payment if the principal borrower falls behind or defaults. The person signing this type of contract is called a cosigner.

While common law has distinguished cosigners (those who sign surety contracts) from guarantors, U.S. law makes the two terms almost identical.

Someone may sign a surety contract to help their child obtain a car loan, start a business, or any other transaction considered by the lender to be high-risk. In many lending situations, it is a requirement for getting the loan. A surety contract can also help the borrower get a better rate.

FindLaw's Financial Consumer Protection and Start-Up Financing sections can help you with any questions on those topics.

Surety Contracts and Risk

Surety contracts are intended to minimize the risk to the lender. This is because a lender would rather not spend money on collection agencies or lawyers to secure the repayment of a loan if the borrower defaults.

Anyone asked to cosign a loan should understand their risk should the loan go unpaid. Nearly three out of four cosigners end up repaying the principal borrower's loan, according to research cited by the Federal Trade Commission (FTC).

To put it in clear and simple terms: A borrower asks a friend or a parent to cosign a loan because the lender would not otherwise give this person the loan. That alone illustrates the risks the cosigner is assuming.

Suretyships, Surety Contracts, and Surety Bonds

The terms suretyship, surety contract, and surety bond are related but refer to different aspects of financial agreements:

  • Suretyship: This is a broad term describing the relationship between three parties. These parties include the principal or obligor (the one making the promise), the obligee (the one receiving the promise), and the surety (a third party ensuring the promise is fulfilled). A suretyship can encompass various types of financial assurances and guarantees.
  • Surety Contract: A surety contract is a more specific agreement within the framework of a suretyship. It outlines the terms and conditions of the surety's commitment to support the principal in fulfilling certain obligations. This can include various financial guarantees provided by the surety.
  • Surety Bond: A surety bond is a type of surety contract that involves a three-party agreement. It includes the principal, the obligee, and the surety. Surety bonds are commonly used in the construction industry to ensure the principal fulfills their obligations. If not, the surety steps in to cover losses.

Types of Surety Bonds

Surety bonds serve various purposes. Provided by either insurance companies or surety companies, the types of surety bonds include:

  • Performance bonds: A type of bond that guarantees that contractors fulfill their contractual obligations
  • Payment bonds: A type of construction bond that assures payment to subcontractors and suppliers
  • Bid bonds: Essential in the bidding process for construction contracts, bid bonds ensure that the winning bidder will fulfill the contract if awarded
  • Contractor license bonds: Serves as a financial guarantee to ensure that a contractor adheres to the regulations and requirements of their licensing authority
  • Permit bonds: Often required by municipalities, guarantee compliance with regulations and codes
  • Court bonds: Utilized to secure legal obligations
  • Commercial surety bonds: These encompass a wide range of guarantees, including fidelity bonds for employee dishonesty and license and permit bonds for various business activities. These bonds differ from insurance policies as they do not transfer risk. Instead, they provide financial assurances within specific contractual agreements or legal obligations.
  • Fiduciary bonds: Also known as a probate bond or executor bond, it is often required in legal situations involving the management of someone else's assets or finances.

When obtaining a surety bond, the bonding company considers factors like the bond premium and the amount of the bond. Understanding bond requirements is crucial when engaging with bonding companies for specific contractual or legal obligations.

Cosigner's Notice

Federal law requires lenders to provide surety contract signees with a cosigner's notice. The notice contains the following language:

You are being asked to guarantee this debt. Think carefully before you do. If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.

You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.

The creditor can collect this debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record.

This notice is not the contract that makes you liable for the debt.

If You Do Cosign a Loan

The FTC offers the following advice for individuals who have agreed to sign a surety contract:

  • Make sure you can afford to repay the loan. Otherwise, you could be sued or have your credit rating damaged.
  • Understand how your liability for someone else's loan can hurt your ability to get other credit, even if you are not asked to repay the debt, since it will be included on your credit report.
  • Make sure you are willing to relinquish a given piece of property used to secure a loan, such as a car.
  • Find out how much money you might owe should the borrower default, since it could include late fees, court costs, or legal fees. In some cases, you can limit your liability to just the principal balance of the loan.
  • Ask for written notification if the borrower is late with a payment.
  • Keep copies of the important loan documents.
  • Check state law for any additional cosigner rights that may apply.

Signing a surety contract is not always in the best interests of the cosigner, but risks can be mitigated with proper preparation.

Legal Help

If you're dealing with a surety contract or surety bond and need assistance, hiring an attorney can be very helpful. A consumer attorney can guide you through the terms and conditions of the contract, ensuring you understand your rights and obligations. They can also help navigate any legal issues or disputes that may arise.

You can explore resources provided by organizations like the Consumer Financial Protection Bureau (CFPB) or your state consumer protection agency. These resources offer valuable information to help you comprehend your rights and make informed decisions when dealing with surety contracts or bonds.

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