What are construction bonds?
A construction bond, also called a contract bond, is a type of surety bond that investors, owners, or public entities use for an extra layer of protection in construction projects. In short, these bonds act as insurance for clients – protecting them in case of contractor default (work is not completed per the contract).
Every surety bond is a legally binding contract between three parties. In this case, the three parties are:
The contractor or subcontractor assigned to the project
The person, business (often a project owner), or public entity hiring the first party to do the work
The company that issues the bond and ensures the work is done properly
A construction bond guarantees that a contractor performs the work according to the project’s specifications. The bond protects the owner financially, so they aren’t left high and dry if the contractor fails to finish the job or does shoddy work. It also protects the project owner against project disruptions and cash flow problems.
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How do construction bonds work?
- 1. A project owner lists a job.
- 2. The project owner requires any contractors who are bidding the job to put up a bid bond.
- 3. The project owner selects a contractor (usually the one with the lowest bid) to take the project.
- 4. The contractor agrees to complete the work according to the contract. They must be able to manage the project financially and perform the job to the quality specified in the agreement, avoiding contractor default. They do this by putting up a performance and payment bond.
- 5. The contractor either fulfills the policy terms or is held liable (along with the surety company).
Why do contractors need construction bonds?
Contractors must obtain various types of construction bonds for government or public works projects and many private-enterprise construction jobs. A bond reassures the project owner that they’re in good hands as the contractor commits to perform the job according to the project agreement. In a nutshell, a construction bond reduces the risk of financial loss for the project owner (in case of contractor default).
Bond Requirements for Construction Projects
You can follow this process to obtain a contract bond:
1. Review Project Requirements
Determine whether you need a contract bond (and what types) by reviewing project requirements for a job you want to win.
2. Get a Bid Bond
If the project requires a bond to participate in the bidding process, request a bid bond from a surety bond provider (like ZipBonds). Submit the bond along with your project proposal.
3. Win a Job
If you win the job, obtain a performance and payment bond so you can complete the job.
4. Finish the Job
Once you’ve wrapped up the project, you may be required to obtain a maintenance bond to make repairs if project owners find defects.
ZipBonds provides thousands of bond options, including construction bonds.
Types of Construction Bonds
Here are the main types of construction surety bonds:
By placing a bid bond, you’re telling project owners that you’re serious about your bid proposal for a project. It also guarantees that you have the financial assets and ability to accept the work (and will do so if you win the bid). If your bid is accepted and you don’t take the job, or you take the job and fail to provide a performance bid, the project owner can make a claim on your bid bond.
A performance bond will replace the bid bond after you accept and agree to take a job. This bond acts as security for the project owner, ensuring you’ll complete the project according to the contractual agreement. Again, if you don’t, the project owner can make a claim on the bond.
Payment bonds are also called labor and material payment bonds. A payment bond offers suppliers and subcontractors financial security if their prime contractor is not able to pay them for work that they completed. Payment bonds are typically issued in conjunction with performance bonds.
A supply bond holds all suppliers involved in the construction process accountable. It ensures they provide equipment and materials as promised in the purchase order. If they fail, the bond will cover the purchaser’s loss.
Maintenance bonds are also essential, acting as guarantees that contractors use quality workmanship. These bonds are suitable for a set period after project completion. If someone discovers a flaw before that period ends, they can make a claim for reimbursement on any necessary repairs.
How much do contract bonds cost?
The cost will vary based on the type of construction bond, the amount of coverage, your credit history, experience on similar jobs, your financial history. Generally, surety bonds can cost anywhere from 1% to 3% of the total bond amount. For example, if you require a $50,000 bond policy, you could pay anywhere from $500 – $1,500.
Frequently Asked Questions
You may still be able to get the bonds you need if you have bad credit, but your premium may be higher. Your credit score will play a role in how much a surety will charge you for a construction bond. Working with a direct surety provider like ZipBonds will give you access to a larger pool of sureties to help you find an affordable solution.
Someone may file a claim on your bond while the bond is active, and then the surety will begin an investigation to determine the claim’s validity. If invalid, no further action will be taken. If valid, typically the surety and the contractor will come to a solution to resolve the issue. The surety will settle the claim, then you’ll be indebted to them until you pay them back.
- Identify which contract bond you need and the coverage amount.
- Contact a surety bond provider to apply for your bond. You may need financial statements, references from a bank and previous project owners, and a work-in-process schedule.
- Get a quote to determine the cost of your contract bond. It may cost anywhere from 1–3% or more of the total bond amount.
- Approve a quote and pay the premium amount.
- Your surety provider will send you the bond.
- Double-check that all the information is correct and error-free. If there’s an error, contact your surety to fix it immediately.
- File your bond with the project owner (or whoever requires the bond).