There are several kinds of surety bonds contractors might be required to provide, especially if seeking federal construction projects. Some of these bonds are required in different industries as well, so it’s a natural question to ask what a contractor payment bond is. Some surety bonds can even sound similar to each other or use similar names, so it’s easy to get confused over how payment bonds work vs. other kinds of construction bonds.
Below you’ll find the basics of payment bonds, including how payment bonds work, how much a payment bond costs, and a way to make getting them far easier for the contractor. Read on and discover how the surety bond applies to the construction business.
Construction Payment Bonds Explained
A payment bond is a type of surety that guarantees to laborers, material suppliers, and subcontractors that they will be paid in accordance with the contract between them and the contractor. Payment bonds are always required for construction projects that are tax dollar funded, but they aren’t uncommon in the private sector either. It’s often better to assume that you’ll need to obtain a payment bond to successfully bid on a construction job than be unprepared for getting one.
It isn’t unusual for contractors to equate payment bonds with insurance, though this assumption is incorrect. One of the differences between a payment bond and an insurance policy is that the bond doesn’t protect the contractor who has purchased it. A payment bond is designed to protect laborers, suppliers, and subcontractors from not being paid. If that were to happen, they are able to file a claim against the bond and the contractor would be obligated to reimburse the surety if the surety pays out on the claim.
How a Contractor Gets a Payment Bond for Construction
A contractor is able to obtain a payment bond by applying for one from a surety provider. It’s important to know that a surety will look over a contractor’s experience and financial capabilities before providing the payment bond. The factors they’ll pay most attention to and qualifications depend more on the size of the bond a contractor needs, but always involves a deep look at their experience and financial capability. More specifically, a surety provider will explore the following:
- Does the contractor have the labor and necessary equipment to complete the project they’re being given a payment bond for?
- What is the contractor’s personal credit like?
- If a sizable payment bond is needed (more than $750,000), a surety will require financial statements from both the company and the person who owns the company.
- Does the contractor have the necessary internal controls to account for and manage the work?
- What is the contractor’s track record of profitable jobs completed?
- Was a CPA involved in preparing the contractor’s financials?
Each of these factors matters to a more or lesser extent depending on the size of the payment bond, but each should be accounted for and looked at before applying. Anything found lacking or prepared incorrectly will extend the bonding process and potentially cost you more than your time.
How Much Does a Payment Bond Cost?
A payment bond is often proved along with a performance bond, with the premium being based on the amount of the contract. Since the two are often issued together, it’s a natural assumption that there would be a double cost to have a payment bond and the performance bond, but that isn’t the case. Though, it’s important to note that if just a payment bond is issued, then the premium is less than if the two surety bonds are given together. If you’re a newer contractor business, it would be best to also read this article: What Sureties Look For When Bonding Newer Construction Companies – CSBA
In general, a payment bond cost is calculated from these factors:
- The overall financial strength of the contractor and owners
- Whether the financial statements are prepared by a CPA or internally
- The size of the payment bond required
- Whether the payment bond is based on personal credit or financial statements given to the surety provider
Working with a surety specialist can help you gauge what the likely premium will be when seeking a payment bond. If you’re tempted to work with your insurance agent for this process, please read here to see why that isn’t the best decision to get a surety bond: Difference Between Surety Specialist & Insurance Agent
Payment Bond Process Made Easier
Understanding how to navigate surety bonds in the construction industry can be a lot to take in. That’s why we at CSBA write these articles, to take the confusion and potential misunderstandings out of the surety bond business. We also publish this information to demonstrate our expertise with surety bonds for contractors, so they know that we can successfully guide them through these waters and help them grow their bonding capacity.
We at CSBA have a team of underwriters with over 225 years of combined experience, dedicated to building the California contractor, and helping them get the bonds they need to develop California. With our professional expertise, we have key relationships with surety providers and access to programs many other surety agencies don’t. Avoid the hiccups and mishaps so easily found in the bonding process, work with the experts in payment bonds.