What are Construction Bonds?
Construction bonds are a form of a Performance & Payment bond. Given that modern bonds have their roots in the construction industry, these terms are used interchangeably. A construction bond is a type of surety bond utilized by an owner of a construction project – thus the term construction bonds. It protects against a catastrophic event that would cause a major disruption of the construction project, such as the inability to complete the job by the general contractor, or the general contractor's inability to pay his subcontractors, or finally the bankruptcy of the contractor. In addition, a construction bond can be a warranty bond to make sure that the job actually conforms to the specifications of the contract.
How Does a Construction Bond Work? Construction Bonds Explained
Like a typical surety bond, there are three parties to the bond. First, there is the surety company. This is the company that is guaranteeing the work of the general contractor. The general contractor is the obligor. The person that would be the beneficiary of the bond from a failure of the obligor (the general contractor) is the obligee – the owner of the property.
It’s a question that we are asked pretty consistently: How do we get the lowest bond rate possible? Well, construction bond rates can vary – the rate depends on the type of bond, as well as the bond agency that you end up using.
How to get the Lowest Construction Bond Rate
There are a number of ways that you can work to receive lower rates. By following these tips you can work to drive down the cost of your surety bonds. That way, you can make sure that you put more money back into your business or into the construction process (to deliver a higher quality result), as well as have less stress about your business finances.
Here is our most popular advice on ways for you to find the cheapest rates on construction bonds (outside of our top-ten that we posted):
Construction Bonding Company
Compare bonds through multiple surety bond companies: certain agencies will be able to offer bonds from many different potential sources. Your bond agent should be choosing from multiple sources, which will allow you to drive the price of your bonds down because you will have more options to pick from. Long-established agencies generally have access to different types of surety bonds, or access to different underwriting criteria, so it's important to shop around and pick an agency that has more options available to you.
What Type of Bond do I Need For Construction?
Construction Bond Types – Don’t just consider a single type of surety bond. Some bonds are based on credit rating while others are based on tangible net worth. Go ahead and consider an agency that won't look into your credit rating: some surety bonds require you to put up your own personal credit rating as well as the finances of your business. Going into a surety bond agency that doesn't require any of your credit rating, especially if you have a poor credit history, is important to reducing the cost of your construction bond rates.
But be forewarned: if you have failed to deliver several construction projects or your business is experiencing some financial difficulty, there can be real problems when it comes to receiving a fair deal on construction bond rates.
Contractors Bond – Cheaper Can be Better
Look at projects that require cheaper bonds: certain construction projects don't require the use of performance bonds or other fully-insured bonds. If you can find a construction project that only requires the use of the bid bond you can work to save money off of the total cost of your construction bond process.
The less amount that you have to tie up with financial institutions, and the less people that you have to involve in the bond purchasing process, generally means the less cost to you in the end. Pick your construction projects wisely and you can lower the cost of construction bond rates for your company.
By using these tactics you can find the lowest rates available.
Construction Guarantee Bond
A construction guarantee is an agreement that provides assurance that the construction project will be finished timely and according to the specifications within the contract. The construction guarantee can be done in several different ways.
One way is to have the construction company guarantee its own work. This is a first party guaranty. A first party guarantee is good in that the company is providing more than just contractual assurance, but also additional good faith and good works assurance that they will perform. What this does is allow the owner some peace of mind that the company will not simply look for loopholes in the contract, but the implied understandings between the parties will also be enforceable.
Construction Bond Insurance
Another way is to have the construction company get a guarantee from its owner. This guarantee adds an additional element in that there is some “skin in the game” with regard to the project. When this occurs, the owner has an incentive to make sure that the company pays attention to the contract terms and also makes certain that the owner is left satisfied with the work.
Another good way is for the company to get a bond. A performance and payment bond is a three way contract instead of a simply guarantee. What happens is that the construction company looks for a third party to provide surety. This third party is typically a large insurance company, like AIG. AIG would then provide this surety through the performance surety bond to the owner of the property. If the contractor would default under the terms of the construction contract, then the owner would first look to the surety for remedy. The surety could then find another company to finish the job, or fix the job, according to the original contractual terms. Alternatively, the surety could pay the owner financial compensation as damages for the poor work. Then, the surety would look to the construction company for indemnification on this payment.
In Federal Government work, a performance/payment bond is required pursuant to the terms of the Miller Act. State and local governments have passed rules, known as little miller acts, that require performance and payment bonds at the state and local level.
How do Construction Bond Lines Work?
This is typically the total dollar limit that you have available for bonding with your individual company. This is sometimes called your bonding capacity. When you set up your account with your bonding company (surety) you're usually given two different numbers for your construction bond lines. These two numbers are your single limit as well as the aggregate limit. The single limit in construction bond lines represents the total maximum bid that you can use with a single contract whereas the aggregate limit is the maximum total dollar value of bonds that you can have available for all of your construction work at one time.
Construction Bonding Capacity
When you first receive your construction bond line, it is usually represented by just two numbers. You might get something along the lines of 250,000 over 500,000 for a line. Basically what this means is that at any one time you can have construction security bonds out on two projects of $250,000 in value for your company. You can think of the aggregate line as a total credit limit for the amount of bonds that your company can have out whereas the single limit is more of a transaction limit for the total value of a single bond. Essentially these limits act based off of the value of your company to help protect your construction company and you as a contractor while ensuring you can still take out security bonds on any project that you complete.
There is no absolute guarantee that you will be approved for security bonds based off of your bond lines. These lines are simply placed as a guide for the maximum amount that you should be considering in any security bonds application. Make sure that you keep within your bond line limits or you could run into problems with your bond agency.
If you are extremely limited in your bond lines, a good surety agency will be able to tell you how you can increase your bond line limits (so that you can take on more projects). You can also reduce the total amount of surety bonds that you have out with the help of your surety bond agency. Agents can remove items from your work, which can help to free up more money with your aggregate bond line. It will take some negotiation as well as some help from your surety bond agency but you can make construction bond lines work for your company and understand them when you are approaching surety bond agencies.
What is a Construction Bond?
A construction bond is comprised of two parts: 1) Performance bonds, and 2) Payment bonds. These are two types of bonds that are used by general contractors and subcontractors in the construction industry. The Performance and Payment bonds provide a guarantee that the construction contractor will perform according to the terms of the agreement as well as pay all labor and material vendors.
How do you become bonded in construction?
You need to apply to a construction surety bond company. The surety will typically require an application, plus information about the job. If you want to get bonded for more than $450,000-500,000, then most sureties will require financial statements from your company plus a personal financial statement (and maybe other information, such as a work-in-progress report, accounts receivable aging report, accounts payable aging report, etc.).
What are the three major types of construction bonds? Why are they required?
There are three major types of Construction bonds. They are: 1) Bid Bonds; 2) Performance Bonds; and 3) Labor and Material Bonds (also called Payment Bonds). A bid bond is required to bid on many projects. It guarantees that, if you bid and win the job, that you will accept the job and if not, then you will pay a penalty (usually 5% or 10%). A performance bond guarantees that you will perform the job according to the terms of the contract. A labor and material bond guarantees that you will pay all material vendors, subcontractors, etc. for their work on the project.