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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   March 2019

Surety Bonds Protect You and Your Clients

It pays to learn the ins and outs of these security instruments and how they differ from insurance

There are thousands of mortgage brokers who assist clients in acquiring commercial and residential properties throughout the country — with more professionals entering the industry each year. Although the mortgage business is growing, added regulations have complicated the process of becoming a licensed broker.

Each mortgage broker, or brokerage company, must follow a set of rules in order to run their business legally and successfully in each state they operate. Among the requirements is getting a mortgage-broker bond.

A mortgage-broker bond is a type of surety bond that protects clients of licensed brokers and shows that a broker’s business is legitimate. This type of bond works as a third-party guarantee that the broker will operate in a way that is in line with the state’s laws for doing business. Mortgage brokers need to know about surety bonds, how they differ from insurance, their pricing and the impact of personal credit on getting a bond.

The need

Throughout the United States, mortgage brokers are required to abide by the rules set by individual states regarding how they do business with their clients. Obtaining a surety bond is part of this process because it serves as a safety net of sorts in the event a broker acts fraudulently or out of line with state laws.

A surety bond may seem similar to insurance coverage, but it works much differently in practice. In fact, many brokers confuse surety bonds and insurance — although they cover two separate business needs.

It is important to know the differences between surety bonds and insurance. This will allow you to make the best choice for your brokerage.

Definition

Surety bond

A surety bond is a financial guarantee against future work performance and obligations, including requirements outlined in state laws and regulations. If a mortgage broker acts in a way that breaches the terms of the surety-bond contract by committing fraud or other transgressions, the client has a right to file a claim against the broker for damages or losses incurred. If the claim is deemed valid, the surety-bond issuer will pay those costs up to the amount covered by the bond. A surety bond is not an insurance policy, however, and the broker is normally required to reimburse the surety company for claims paid.

Source: Investopedia

The differences

The most distinguishing difference between surety bonds and insurance coverage is who is protected. With surety bonds, mortgage brokers purchase a bond in an amount that meets the state’s bond requirement, not for protection against loss to the business, but for protection extended to clients.

A claim against a surety bond is paid by the surety company to the broker’s client to cover incidents of fraud or financial damage. The mortgage broker does not receive payment from his or her own surety bond.

Insurance coverage for a brokerage business works differently. A mortgage broker purchases insurance, typically liability coverage, that protects the business against financial loss or damages. These damages could be due to natural disasters, fire, theft, or legal liabilities such as a lawsuit. When a claim is made against an insurance policy, the insurance company pays the mortgage broker up to the limits of his or her coverage for damages incurred.

In addition to these drastic differences, surety bonds for mortgage brokers are usually mandated by state regulators. This requirement is meant to add a level of protection for clients, and all licensed brokers must abide by their state rules and regulations.

Insurance, on the other hand, is not always a require- ment to operate a legal business. It is, however, recom- mended that insurance also be purchased to safeguard  the brokerage against unforeseen events that could lead to financial stress.

Bond mechanics

Surety bonds and insurance coverage also have significant differences as it relates to pricing and payments. Mortgage-broker surety bonds are priced as a percentage of the total bond amount. The percentage charged to the mortgage broker depends on certain factors, including their credit history, the business’ history of bond claims and the financial condition of the brokerage.

Insurance pricing does not rely on personal credit history, but instead is determined by the risk the mortgage broker poses to the company. If there have been several claims against a broker’s insurance policy in the past, for example, an insurance company may charge more for a new policy than if claims were minimal. In determining prices, insurance companies also evaluate the location of the business, the amount of time the company has been operating and the nature of the policy coverage being sought.

Surety bonds and insurance policies also differ in how they pay out when claims are successful. Insurance providers pay benefits to the insured, or the mortgage broker, up to the policy limits. Surety agencies pay the broker’s client, or claimant, up to the bond amount, but then require bondholders to repay that amount over time.

Personal credit

Because a broker bond is a form of extended credit on behalf of the mortgage professional, surety agencies take a close look at a broker’s financial track record. They want to ensure there are no issues with missed or late payments, overborrowing through credit cards or loans, or more significant negative marks like bankruptcies, foreclosures or court judgments.

These signs point to a higher risk for borrowers working with such a mortgage broker. Surety agencies are cautious about taking on new brokers with such credit missteps in their past.

An individual with less-than-perfect credit can still get a broker bond, but it will likely come at a higher price. The increased risk a surety company takes on when providing a bond to a mortgage professional with bad credit means the cost of the bond, which is calculated as a percentage of the bond amount, is higher. There are steps you can take, however, to ensure you get an affordable mortgage bond — even with bad credit.

Before applying for your new bond, be sure to know exactly what is in your credit report and what items may represent a red flag to the surety company.

Affordable bonds

Although it may seem like you are facing a substantial uphill battle when getting a mortgage-broker bond with bad credit, you aren’t completely out of luck. The first step in obtaining a bond that meets your needs and your budget is to check your credit.

Before applying for your new bond, be sure to know exactly what is in your credit report and what items may represent a red flag to the surety company. If there are entries on your credit report that seem inaccurate, or wrong altogether, work to dispute those items before submitting your application.

Once you know what is in your credit report and you resolve any negative entries that are incorrect, your next step is to work toward establishing good credit. Improving your credit does not happen overnight, but what will help is making sure you make payments on time, use your credit lines responsibly and only take out the credit you need.

Finally, it is important to work with the right surety company. You should find one that understands that credit issues happen; is willing to evaluate other factors, like your bond-claims history and business financials; and also can offer you several bond options.

• • •

Getting a mortgage-broker bond is normally a requirement to be licensed in the state where you work, but the process does not have to be complex or excessively costly. Know why the bond is needed and how your credit impacts its price, then be sure to select a surety company that can help you every step of the way.

Also, take time to understand the differences between surety bonds and insurance, and when each is needed to protect your business. Taking these small steps will help you fulfill your promise to the state and your clients as you continue building a career as a mortgage broker.


 


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