Bond vs. letter of credit by the numbers
- $25,000
- California contractor license bond, required since Jan 1, 2023
- CA Business & Professions Code, 2023
Two guarantees, built differently
Both instruments promise a third party that an obligation will be met. A surety bond is a three-party guarantee: you, the obligee, and a surety company that underwrites you and stands behind the obligation. A letter of credit (LOC) is a two-party bank product: your bank promises to pay the beneficiary, and it holds your credit line or cash to back that promise. The difference in structure is what drives the difference in cost and risk.
| Surety bond | Letter of credit | |
|---|---|---|
| Backed by | A surety company | Your bank |
| Your capital | Bank credit line stays free | Ties up your credit line or cash |
| Cost | Annual premium, a percentage of the amount | Bank fees plus reduced borrowing power |
| On a default | Surety investigates before paying a valid claim | Often paid to the beneficiary on demand |
| You repay | The surety, under your indemnity agreement | The bank, immediately |
Capital is the real difference
The biggest practical gap is what each does to your borrowing capacity. A bank issues an LOC against your credit facility, so the full face amount is no longer available to fund payroll, materials, or a new job. A surety bond does not touch that line. For a growing contractor, keeping the bank credit free is often worth more than the premium difference. It is the same reason a bond usually beats the cash deposit a state will accept in lieu of a license bond.
Cost and risk
A bond costs an annual premium, a percentage of the bond amount set by underwriting. An LOC costs bank fees plus the opportunity cost of the credit it locks up. On a default the two also behave differently: a surety investigates a claim before paying, which can protect you from an unfair draw, while many letters of credit are drawn on demand with little review. Either way you ultimately repay, the surety under your indemnity agreement, or the bank the moment the LOC is drawn.
When each makes sense
Some obligees specify one or the other; many accept either. When you have the choice, a bond usually preserves more capital and cash flow, which is why contractors lean toward it, especially as their bonding capacity grows. An LOC can still fit a specific banking relationship or a requirement that only a bank instrument satisfies.
If an owner offered you the choice, or your bank quoted an LOC, let us price the bond next to it. Start a quote and we will show you the real numbers, capital impact included.