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Construction Bonds

What Are Construction Bonds?

 

Construction Bonds are a type of surety bond written specifically for contractors. These bonds include Performance Bonds, Payment Bonds, Bid Bonds, Maintenance Bonds and Supply Bonds. Construction Bonds are a three party agreement. The contractor is referred to as the Principal. The contractor’s obligation is guaranteed by a third party which is the Surety or Bond Company. The party that is requesting the bond and benefiting from its guarantee is the Obligee. For Construction Bonds, this is the Project Owner and/or Lender, the Developer or an Upstream Contractor

 

Construction Bonds - This shows the type of construction bonds and their relation to the surety bond company, principal and obligee. The background is construction tools

 

Bid Bonds

 

Bid Bonds guarantee that if a contractor is the low bidder and awarded a project, that contractor will enter into a contract with the owner and if asked, provide other construction bonds such as performance bonds, payment bonds and maintenance bonds. 

 

Bid Bonds protect owners from the cost of having to rebid projects if the contractor will not honor their bid price. If a contractor is the low bidder and will not honor their bid amount, the owner can submit a claim on the bid bond. Without bid bonds, contractors would be able to withdraw their bids with little or no consequences. 

 

Bid bonds provide the owner with a secondary benefit by acting as a prequalification process. By requiring a bid bond from a corporate surety, an owner can be sure that a professional surety underwriter has looked at the contractor's qualifications to perform the work and believes they can successfully complete the project. You can read more about bid bonds here

 

Performance Bonds

 

Performance Bonds guarantee that a contractor will complete a project according to the contract terms and at the contract price. A performance bond benefits the owner because they can be sure they will get their project completed for the at the agreed upon price. If the contractor can not build the project for the price, the owner can make a Performance Bond Claim against the bond. Without a performance bond, an owner would be responsible for the cost overages if a contractor can not complete the work. 

 

Performance Bonds also benefit contractors. First, they act as a prequalification and help to set themselves apart from competition that may not be able to provide a bond and complete such work.

Secondly, contractors can ask for a performance bond from their subcontractors and suppliers to manage their own risk. Performance bonds can be a valuable tool against Subcontractor Default and price escalations. You can read more about Performance Bonds here.

 

Payment Bonds

 

Payment Bonds provide a guarantee that the Contractor is going to pay their subcontractors, material suppliers and bills on a project. If the contractor does not or can not, a claim can be submitted to the bond company. This is a valuable tool for owners, lenders and the general public. It ensures that the project will be free of Mechanic’s Liens

 

Likewise, Payments Bonds benefit subcontractors and suppliers. On a project with a payment bond in place, the parties can be sure they will receive payment for the work they have done under a construction contract. You can read more about payment bonds here

 

Maintenance Bonds

 

A Maintenance Bond guarantees that the project will be free from defects for a specified period. These bonds can also be referred to as Warranty Bonds. Maintenance Bonds protect the owner’s investment by ensuring that the contractor will come back to correct work during the maintenance period. Generally, maintenance periods should not exceed 24 months. Everything breaks down over time and the contractor and surety bond company do not want to be making repairs forever. You can read more about Maintenance Bonds here.

 

Supply Bonds

A supply bond guarantees that material or equipment will be provided at an agreed upon price. Supply Bonds protect contractors against price escalation from material suppliers. Supply bonds can be a useful tool when future prices are uncertain such as when a product may not be needed for a while, prices are constanly influx or when there are a limited number of suppliers providing material or equpment.

 

Construction Bond Guarantees - This chart shows the different type of construction bonds and what they gurantee. The top is a picture of a construction crane while blue and green separates the bonds.

 

Why Am I Being Asked for a Construction Bond?

 

Construction Bonds are required on most public projects. In fact, The Federal Miller Act requires that any project with $150,000 or more of Federal money, must be protected by Construction Bonds. This ensures that Public’s funds are protected by keeping projects completed at the contract price. It also ensures that Subcontractors and Suppliers are paid because they cannot file liens on Public buildings and improvements.

Most states and municipalities have similar requirements. The dollar amounts to require construction bonds may vary by location though. These are referred to as "Little Miller Acts".

Additionally, many private projects require construction bonds as well. This is a way for general contractors to protect themselves from subcontractor risk and price escalations. Additionally, many lenders require construction bonds when lending money to owners and developers. This provides protection so that mechanic’s liens are not filed against their collateral and that borrowers will not need to return for additional capital to address cost overages. 

 

What Do Construction Bonds Cost?

 

The cost of construction bonds depends on the strength of the contractor. Contractors with strong financial conditions, good experience and systems can usually get construction bonds for less than 1% of the contract amount. Contractors with less experience or weaker financial conditions may pay rates as high as 3% of the contract amount. Most contractors can expect to pay 0.5% - 3% of the total contract amount. Long term warranties, long completion times, and Design Build projects can increase the cost of Construction Bonds. You can read more about Construction Bond Costs here.

 

Construction Bond Cost - This shows that construction bonds cost between 0.5% - 3%. background is a piece of construction equipment with $100 bills next to it. Blue text box

 

Bid bonds on the other hand are free from most brokers. Axcess Surety Bonds does not charge for bid bonds. We provide these as a service to our construction bond customers. 

 

How Do You Get a Construction Bond?

 

The underwriting of construction bonds depends on the size of the contract being bonded. For projects of $500,000 or less, contractors can get a bond with a simple credit check. Most of these construction bonds can be purchased instantly and in minutes. Just click on one of the buttons below. 

 

Bid Bond Instant Purchase

 

Performance Bond Instant Purchase

 

Payment Bond Instant Purchase

 

For larger projects, contractors need to submit full underwriting documents. Construction Bond underwriting is referred to as the 3Cs which stand for Credit, Character, and Capacity. You can read more about these and how underwriters look at each here. The most basic information needed for larger construction bonds include: 

 

  • Three years of company financial statements
  • An application
  • Personal Financial Statements on the shareholders
  • A copy of the contractor’s bank line of credit if applicable

 

For Performance Bonds, Payment Bonds and Maintenance Bonds, we will also need a copy of the contract. For Bid Bonds, we usually need a copy of the bid specifications

 

How Long Does it Take to Get Construction Bonds?

 

Once we receive all the underwriting information, we can have construction bonds for most contractors within 24 hours. It may take longer for contractors with credit challenges. 

 

Construction Bonds Require Indemnity

Construction Bonds require that the contractor indemnify the surety bond company providing the guarantee. This means that if a loss occurs and the bond company pays out, they will come back to the contractor for reimbursement. Contractors often misunderstand indemnity and view construction bonds as insurance. Construction Bonds more closely resemble a credit product, however. They are not insurance. To get construction bonds, contractors will be required to sign a General Indemnity Agreement. Contractors should review this document carefully and understand what they are signing before requesting construction bonds. You can read more about indemnity and General Indemnity Agreements here

 

Others Bonds May be Needed

Contractors that need construction bonds usually need License and Permit Bonds as well. These are bonds that are required for contractors to operate and maintan licenses in various states and municipalities. You can read more about these bonds here.

 

Alternatives to Construction Bonds

Some owners may accept Irrevocable Letters of Credit as an alternative to construction bonds. Contractors should be skeptical of doing so. A contractor has very little defense to a claim against an irrevocable letter of credit. Additionally, using a letter of credit will tie up the contractor's borrowing ability and that liquidity may be needed for the project or business. Contractors can learn more about the differences of using a Contract Bond compared to a letter of credit here.

 

Understanding Construction Bonds does not have to be difficult. Axcess Surety is an expert in the field of construction bonding. We unlock the door to making bonding easy. Contact our construction bond experts anytime.

 

Other Frequently Asked Questions

 

Do Construction Bonds Require Collateral?

Generally No. Construction Bond companies generally do not take collateral unless a claim is filed. However, if the contract has financial challenges, collateral may be a way to gain approval of the bond.

Can You Obtain Construction Bonds with Bad Credit?

Yes there are ways to obtain construction bonds in almost all circumstances. Profitability, liquidity and net worth are more important than credit. Others can use tools such as the SBA Surety Bond Guarantee Program, Collateral, or Escrow.

How Do Construction Bonds Work?

The Principal pays the Surety Bond Company a premium. In return, the Surety provides a bond to give to the Obligee that promises that the Principal will complete contractual commitment. If the Principal does not, the Surety will step in and provide financial recourse to the Obligee.