From nationwide bank bailouts to the robo-signing crisis, housing market stakeholders know many issues have plagued the industry throughout the past decade. As a result, government agencies nationwide have been reinforcing and re-evaluating industry regulations. One widespread solution has been to strengthen existing surety bond requirements while also establishing new ones. Before we explore the reasoning behind bonding regulations, let's review exactly what surety bonds are and how they work.
1. What surety bonds aren't
Surety bonds should not be confused with financial bonds that are traded; they actually function more like insurance policies. Another common misconception is that bonds are optional insurance policies that enterprises choose to purchase for their professional benefit. However, surety bond protection primarily benefits consumers. As such, professionals who work in the housing market—such as real estate brokers, lenders, servicers, appraisal management companies and property preservation companies—might not necessarily want to purchase bonds, but new licensing regulations require them to do so nonetheless.
2. How surety bonds work
Housing market professionals must adhere to specific surety bond requirements that vary depending on where they work, so hundreds, if not thousands, of individual surety bond forms are used within the industry. When housing market professionals need bonds before they can apply for business licenses, they typically need one of many "license and permit bond" types that guarantee their ability to fulfill license and permit requirements and abide by industry regulations. The exact guarantee provided by a bond depends on its contractual language, which varies by job title and location. For example, the terms of a Kentucky appraisal management company bond differ from those of a California mortgage broker bond.
No matter the specific bond type, each surety bond that's issued brings three entities together in a legally binding contract:
The professional who buys the bond is the principal, the government agency that requires the bond is the obligee, and the insurance underwriter that issues the bond is the surety.
When an insurance company underwrites a surety bond, it approves the principal for a predetermined line of credit that can be used if a claim should be made. Whereas most insurance policies protect the policyholder form financial loss, surety bonds protect consumers from financial loss. If a housing professional fails to meet the bond's specific terms, consumers can make a claim against the bond to recover losses. The ability to collect on a surety claim gives consumers protection from dishonest lending practices, including: Being approved for loans they cannot afford to repay; being charged unnecessary or additional fees; being deliberately targeted for being vulnerable or at-risk buyers; being encouraged to use fraud when applying for a mortgage; being pressured into buying certain loan products such as high-risk loans or loans with higher interest rates; and having an interest rate based on anything other than their credit history
If a valid claim is made against the bond, then the surety will pay reparation up to the bond's full amount. Herein lies the key difference between traditional insurance and surety bond insurance. Indemnification clauses in the bond's contractual language typically require housing professionals to reimburse the surety for any claims paid out. This means the insurance company won't simply assume the loss, which is the case with other types of insurance.
3. Why surety bond requirements are on the rise
With the understanding that problems within the housing industry needed to be controlled, the federal government demanded states tighten mortgage professional licensing with the Secure and Fair Enforcement for Mortgage Licensing Act of 2008. As a result, many state agencies began establishing more rigid surety bond requirements for mortgage brokers, lenders and originators.
In an April 2010 seminar, the National Association of Surety Bond Producers outlined five major reasons new and different mortgage broker bond requirements were on the rise: Economic downturn and mortgage meltdown; voluminous mortgage defaults and foreclosures; many claims and lawsuits against mortgage brokers and their sureties; negligent misrepresentation, fraudulent misrepresentation, consumer fraud, conspiracy; and congressional response to events.
Increased bonding amounts for mortgage professionals protect customers against dishonest lending and brokerage practices. The amount of surety bond protection required of mortgage professionals varies by state, but it usually falls somewhere between $25,000 and $50,000.
Furthermore, in the past few years, more than 10 states have established surety bond requirements for appraisal management companies—and more states have AMC bonding requirements in the works. These bonds ensure that AMCs follow industry regulations and don’t leave appraisers and their consumers out to dry as they have in the past. In the future, these bonding requirements will allow independent appraisers—such as those who were stiffed by AppraiserLoft—to recover losses.
When applying for a bond, housing professionals must prove adequate financial credibility relative to the bond amount. If a surety determines that an applicant has inadequate credentials, then a surety bond will not be issued. If unable to procure a surety bond as required by law, a housing professional cannot be licensed. As such, the surety bond process keeps some individuals from working in the housing market.
Furthermore, since surety bonds are legally binding contracts, housing professionals must maintain them according to law whenever required and then fulfill their terms. Failing to do either could result in fines, legal action and even license revocation. When such action is taken against housing market professionals, their ability to continue working in the industry is hindered, thereby limiting the potential for additional problems in the future.