Regarding surety bonds, many contractors need clarification on payment and performance bonds. These bonds are essential for a contractor’s financial stability and reputation.
Both are required by project owners for federal, state, and municipal projects that exceed $150,000 in value. In addition, most private construction projects also have a contract provision requiring a contractor to get bonded.
The distinction between payment and performance bond can be confusing for some contractors. But if you understand their differences, you can help ensure your construction project goes smoothly.
A payment bond ensures that a contractor will pay subcontractors, workers, and material suppliers following the terms of their contract. It is an essential component of most construction projects.
Many project owners require their general contractors to take out payment bonds before work begins.
They also protect subcontractors and material suppliers from statutory lien rights, which can devastate their businesses if the contractor fails to make timely payments.
While both payment and performance bonds are required by many construction companies when bidding on a job, there is a distinct difference between them. A performance bond guarantees that a contractor will complete a project on time and within the budget.
A performance bond is typically required for city, state, and federal government projects and private contractors. It protects the taxpayer’s investment and assures the client is compensated for losses or damages.
A contractor must often provide a performance bond before beginning a construction and real estate development project. A financial institution, also known as a surety, issues the bond.
The bond cost varies based on the contract size, the applicant’s creditworthiness, and financial strength. Small- to medium-sized contracts can cost between 1% and 3% of the total bond amount. The rate can be slightly higher for larger contracts due to a more in-depth examination of the contractor’s experience, character, and financing qualifications.
A mechanic’s lien is a lien that secures payment for materials and labor provided on a construction project. They are usually filed by contractors, subcontractors, and suppliers who did not receive compensation for the materials or work they offered on someone’s home or land.
Typically, this means the material or labor subject to the mechanic’s lien must go toward improving the real estate. It could include anything from a temporary fence to a permanent wall.
Typically, when a contractor or supplier files a mechanic’s lien, they get all the parties involved in the job to pay attention. In addition, it causes them to stop paying general or specific subcontractors until they get assurances that their claim is paid.
A bond is a contract that protects the owner of the project. For example, if a contractor doesn’t complete the agreed-upon work, the owner can claim money from the surety that issued the bond.
Performance bonds are generally used in the construction industry to ensure contractors deliver their services according to contract specifications and plans. They also protect against unforeseen issues like bankruptcy or insolvency that might prevent contractors from providing their services as promised.
These types of bonds are required for many large construction and government projects. They may also be required for subcontractors and smaller businesses doing personal work.
Performance bonds cost a small percentage of the total contract price, typically around 1% for larger contracts. However, this depends on the underwriting requirements and the project size. A surety agency well-versed in surety bonds can help you determine your exact costs.