Countless instances of unethical mortgage transactions in recent years have motivated government agencies across the country to strengthen the laws that regulate the mortgage industry. A crucial aspect of the crackdown has been stricter surety bond requirements for mortgage professionals. At this point, you might be wondering, "What is a surety bond?" Don't worry; you're not alone.
As a surety professional, I can tell you from firsthand experience that even those required by law to purchase surety bonds often know little about them. Whether you're a mortgage professional who wants to understand how surety bonds work before buying one or a client who wants to know how surety bonds protect consumers, you've come to the right place. This article will explore the reasoning behind mortgage professional surety bond requirements and help you better understand how these little-understood insurance products work.
Each surety bond that's issued to a mortgage professional is a legally binding contract that brings three entities together.
- The mortgage professional who buys the bond is the principal. In doing so, the mortgage professional promises to fulfill the bond's terms, which guarantee compliance with certain industry regulations as outlined on the form.
- The government agency that requires the bond is the obligee. Government agencies enforce surety bond requirements to ensure industry regulations are followed and prevent financial loss at the hands of unethical mortgage professionals.
- The insurance underwriter that issues the bond is the surety. In bonding the principal, the surety provides a financial guarantee of the mortgage professional's ability to fulfill any obligations as outlined by the bond.
Now that we have a basic understanding of how surety bonds work, let's explore the two main reasons mortgage professionals must purchase surety bonds before they can be licensed to work.
1. Surety bonds limit fraud in the mortgage industry.
As we just discussed, surety bonds are legally binding contracts, which means mortgage professionals must fulfill their obligations. Failing to do so could result in fines, legal action and even license revocation. When such action is taken against mortgage professionals and their bonds, their ability to continue working in the industry becomes hindered, thereby limiting the future potential for fraud.
Furthermore, if an individual who's interested in becoming a mortgage professional isn't approved for the bond according to the licensing process, they won't be able to get a license to work in the industry. Applicants with low credit scores and poor financial histories might not qualify for the bond they need, or if they do qualify, their premium might be so high they can't afford to pay for it.
As such, the surety bond application process acts as a kind of screening process that keeps unqualified individuals from gaining access to a position through which they might take advantage of consumers. Surety underwriters essentially act as the first line of defense when it comes to determining who is and is not financially responsible enough to work in the mortgage industry.
2. Surety bonds protect consumers from financial loss.
When an insurance underwriter approves a mortgage professional's surety bond application and agrees to issue the bond, the principal is essentially deemed financially stable enough to be backed with a line of credit. If the bonded mortgage professional—such as a lender, broker, originator or servicer—should choose to engage in a fraudulent or otherwise dishonest mortgage transaction, harmed individuals can make a claim on the bond to recoup losses.
If the surety determines the claim to be valid, it will pay reparation up to the bond's full amount. However, if a claim is paid out on a surety bond, the underwriter will require the principal to reimburse them under the bond’s indemnification clause, which is how sureties avoid losing money when claims are made against bonds. This is the major difference between traditional insurance and surety bonds. If a claim is paid out on an insurance policy, the underwriter absorbs the loss. As such, surety bonds function more as lines of credit than insurance policies, which ultimately holds mortgage professionals accountable for the decisions they make in the workplace.