Whether you're new to the auto industry or have been working in it for decades, you probably know that surety bonds are typically required as a part of the dealer licensing process.

As such, it's important for dealers to be bonded to ensure they manage legally qualified enterprises.

However, dealers often don't understand how these insurance products work, because the government agencies that require them don't offer much of an explanation. No matter how much experience you have as a dealer, you should understand the following five things about surety bonds:

  • Dealers must file their bonds before they can be licensed.

    Government licensing agencies in 47 states require auto dealers to file surety bonds before they can receive their dealer’s license. Individuals in Delaware, Ohio and Vermont do not have to purchase surety bonds to become licensed dealers, but those in every other state do.

    Surety bonds issued for auto dealers are a type of license and permit used to reinforce licensing laws and other industry regulations. Without a surety bond – or other acceptable proof of financial accountability – dealers cannot be licensed.
     
  • Surety bond insurance doesn't protect dealers.

    When purchasing surety bonds, many business owners incorrectly assume the financial guarantees provided by their bonds protect them from costs associated with legal claims.

    Although surety bonds are insurance products, they function more as lines of credit that can be used to pay for work-performance issues. Consumers can make claims on bonds to gain financial reparation when dealers use alleged unethical business practices.

    Government agencies also can make claims on bonds to collect penalty fines or other costs owed by dealers who fail to uphold bond terms.
     
  • Surety bonds are legally binding contracts.

    As with any other legal contract, dealers should fully understand the terms they're agreeing to. After all, accidentally defaulting on a contract doesn't mean you're any less responsible for your offense.

    Under the bond's terms, you're fully accountable for your actions. Depending on the legal language your state uses on bond forms, you might be contractually obligated to fulfill several tasks as required by industry regulations.

    For example, most bonds specifically prohibit dealers from misrepresenting merchandise, using unethical sales tactics, failing to provide valid certificates of title or failing to pay necessary fees/taxes to the state.
     
  • Failing to maintain a surety bond as required can get you in trouble.

    You must maintain a valid form of surety insurance for as long as you maintain your dealer license.

    This means you need to renew your bond when required to avoid a lapse in bonding coverage. Failing to do so can result in fines, license revocation and even legal action against you and your dealership. Enough said.
     
  • Your bond might be more expensive than you'd like.

    Unexpected surety-bond costs can set dealers back financially. Those who are unable to pay for their bonds won't be able to apply for their licenses. Unfortunately, this means that those who plan to start a small dealership for the first time can have the licensing process delayed until they can pay for their bonds.

Auto bond costs largely depend on an applicant's credit history. Those with credit scores above 700 typically pay a rate that's 1%-5% of the bond amount. Those with credit scores below 700 typically pay a rate that's 10%-20%.

For a standard $25,000 bond, motor-vehicle dealers with good credit will pay $250 to $1,250, whereas those with poor credit will pay $2,500 to $5,000. Some states require $50,000 Department of Motor Vehicle bonds, which means the premium will double.

Although surety bond requirements can be frustrating for auto dealers who have to fulfill them, they really do serve a valuable purpose in regulating the industry.

When auto dealers understand how surety bonds work and why they're required, they're better prepared to undergo the surety bond application process – which means less stress and more confidence.

Danielle Rodabaugh is the chief editor of the Surety Bonds Insider, a publication that tracks news related to the surety-bond industry. As a part of the publication's educational outreach program, Danielle helps leading industry professionals better understand the roles surety bonds play in their industries. For more information on bonding, you can find her on Google+ .