Mortgage Surety Bond

What is a Mortgage Surety Bond?

A surety mortgage bond is generally an agreement between three parties. The three parties are the financial institution, the principal and the surety company. The surety company gives the financial company a guarantee that the principal will honor their mortgage according to the contract. These bonds are used to protect the financial institution from any loss resulted from the principal defaulting on their payments.

Difference from Insurance Policies

A mortgage surety bond differs from an insurance policy. They both have the same goal which is to protect the financial institution, but the cost structure is different. When buying an insurance policy the cost resulting from inevitable claims is added to the premium and divided among all policy holders. It is a way of spreading risk and this is how insurance policy premiums are calculated.

A mortgage surety bond however is an extension of credit, where the surety company expects all principals to fulfill their legal tenders to pay off their loans. The costs of losses are not accounted into bond rates and so premiums are lower then insurance policies. Surety companies are consequently more sensitive to principals not honoring their bonds.

Advantages of Mortgage Surety Bonds

The main purpose of mortgage surety bonds is to be a vehicle to transfer risk from the financial institution to the surety company. The surety company will then hold all the risk of mortgages on behalf of the financial institution for their premium fee.

Mortgage surety bonds are also popular among federal, local and state government financial institutions as they tend to have lower risk thresholds compared tot the private government. They are very common for commercial mortgages in a way to reduce the risk for tax-payer dollars.

Underwriting Mortgage Surety Bonds

As mortgage surety bonds do not account for losses in their financial plans they hold more strict guidelines in giving out surety bonds compared to insurance policies. The principal must be able to prove through their financial and asset information that they can honor the loan that the surety company is issuing a bond out for. This is similar to the steps taken by banks when giving out loans as to determine the principal’s credibility by looking at their credit data and income statements.

Surety companies also are able to ask for collateral in order to reduce the risk of a mortgage surety bond. This is very common among subprime principals and high risk situations. This will drastically reduce the risk involved in giving out a mortgage surety bond for the surety company. Full rights to the collateral will only be released once the loan between the financial institution and the principal has been fully paid off.

There will be cases when the principal does not have any property or has insufficient security to satisfy the surety company’s requirements. In this case surety mortgage bond can be given out where another party (most commonly a spouse, relative or business partner) offers their asset/property as security for the loan. The third party acts as a guarantor for the loan agreement.