7 Things You Need To Know About Construction Bonds

Construction Bonds

Construction bonds are a fact of life for many in the construction industry. That’s why it’s essential to understand how these contract surety bonds work, how they affect the parties involved, and what bonding means from a business perspective. This article covers seven things you need to know about construction bonds.

1 – What is a Construction Bond?

Construction bonds, also often referred to as contract bonds, are a category of surety bonds, used to ensure that a construction project is completed successfully according to all terms, conditions, specifications, and budget. These bonds hold a contractor or construction company, (also known as the principal), financially accountable if they fail to meet their contractual obligation. For example, if any work was not performed according to specifications, and the contractor is either unwilling or unable to correct the work, the project owner, (also known as the obligee), could use the construction bond to access funding to hire a new contractor to correct the work.

2 – How does a Construction Bond work?

When the outcome of a construction project fails to meet all terms, conditions, and specifications, the project owner may have a right to file a claim against the construction bond. The surety company that issued the bond will conduct an investigation into the claim. If it is a valid claim the surety will first see if the issue can be resolved through mediation, as this is can often be the fastest way to achieve resolution. However, if mediation is not possible the surety will quickly make financial compensation to the project owner so the project can continue with as little interruption possible.

A surety assumes a risk when bonding a contract. They guarantee a financial recourse is available to a project owner when a contractor fails, and the surety makes payment directly to the project owner themselves, instead of the project owner having to try and collect the funding from the contractor. The surety is then left to the task of collecting repayment for the claim from the contractor.

3 – How Do Construction Bonds Help with Managing Risk?

Having any substantial construction project completed involves risk. One way to manage that risk is by holding the contractor legally and financially responsible for any failures by requiring they bond the contract prior to construction beginning. If the contractor fails, the surety will step-in and assume the cost to correct the failure when the contractor refuses or is unable to correct the failure themselves.

4 – What are the Main Types of Construction Bonds

The term construction bond actually applies to three types of surety bonds, each related to a different kind of risk. They go by one name simply because construction companies often need all three of these bonds and rely on one surety provider to make bonding seamless:

Bid Bond – These bonds hold the principal accountable for withdrawing from a project they have won a bid to complete.
Performance Bond – These bonds hold the principal accountable if a project fails to meet performance standards established by the project owner.
Payment Bond – These bonds hold the principal accountable if that party withholds payment to subcontractors, laborers, or suppliers for invalid reasons.

Types of Construction Bonds Explained [Infographic]

5 – How Much Does a Construction Bond Cost?

There are a variety of factors used to determine how much it will cost to bond a contract, including but not limited to; the dollar amount of the contract, the type of work being performed, the experience of the contractor, the contractors credit and financial strength, as well as the relationship between a contractor and their surety. The cost of a bond is referred to as the rate, and it is expressed as a percentage of the total contract value.

Example: If a surety approves bonding a $50,000.00 contract with a rate of 2.5%, then 2.5% x $50,000.00 = $1,250.00 (the cost to bond is $1,250.00)

Generally speaking, smaller contracts up to about $500,000.00 will have a rate of between 2% – 4%. Mid-sized contract up to about $2,000,000.00 will have a rate 1.75% – 2.5%. Large contracts over $2,000,000.00 are often as 1%, and not typically higher than 2.%. Again, it is important to recognize the various factors that impact a contractor’s bond rate when trying to get the lowest rate possible.

One of the most important things a contractor can do to ensure they are getting the best rate possible, is to work with a reputable surety agency to develop a relationship. A reputable surety like Viking Bond Service will help a contractor grow and improve their bonding qualifications, which will help result in the contractor getting a better rate.

6 – What Projects Require a Construction Bond?

Construction bonds are commonly required on most public works contracts by cities, counties, and states, as well as federal contracts. However, any commercial project could potentially require a construction bond if the project owner determines that one should be required.

7 – How Bad Credit Could Prevent You from Getting a Construction Bond

The way a bond works where the surety pays a claim then has to seek repayment from the contractor, makes a bond an extension of credit just like any other extension of credit with the one notable exception that a contract does not ever want to have to utilize their bond.

Since contract bonds are a form of credit, if an applicant has bad personal or business credit, getting bonded can be challenging as credit rating is often used to determine risk. An applicant with credit concerns is statistically more likely to cause a claim against a bond, and less likely to pay the surety back for the claim.

The good news is there are sureties willing to work with applicants that have credit concerns. They specialize in assisting these contractors in getting bonded, so they can obtain contracts and continue generating income. If you have bad credit or have been denied a bond elsewhere, rely on Viking Bond Service to do everything possible to get you approved. We even have a special bad credit surety bond program designed specifically to approve more applicants for more bonds.

Viking Bond Service – Building America One Bond at a Time

When you require a construction bond in any amount in any state, work with Viking Bond Service. As a nationwide surety bond company that operates in all 50 states, makes service a top priority, and has abundant resources to offer, we do what other surety bond providers can’t or won’t. If you have questions about any aspect of construction bonds or simply want to talk through the details with a friendly expert, call us at 1-888-278-7389 or use the form on this page. You can also request a free bond quote at any time with no obligation to you.