Construction Bonds 101:
A Must-Know Guide
for Small and
Mid-Size Contractors

What Are Construction Bonds?

As a small to mid-sized contractor, your days revolve around overseeing projects, managing teams, and ensuring every detail satisfies your standards. While these efforts are crucial to your success, understanding the ins and outs of construction bonds, also known as contract bonds, is equally important.

A construction bond is a type of surety bond that guarantees you’ll complete your work as promised. It safeguards your project owners, subcontractors, and suppliers from financial setbacks if things don’t go according to plan.

While construction bonds don’t protect you directly, they provide a safety net for the stakeholders involved in your projects. Plus, securing these bonds brings significant benefits for your business. Not only does being bonded open doors to more project opportunities, but it can also bolster your reputation in the industry, helping you stand out from the competition.

How Do Construction Bonds Work?

Construction bonds work by creating a legally binding agreement between the following three parties:

1. Principal – The person purchasing the bond (you).
2. Obligee – The person or business protected by the bond.
3. Surety – The company providing the bond.

You can apply for construction bonds with surety companies or enlist the support of a surety bond agency or broker. In either case, the application process involves submitting financial statements and providing details about your project experience and creditworthiness.

Once you secure a construction bond, you’re legally required to fulfill your contractual obligations. If you fail to do so—due to using substandard materials, not paying your subcontractors on time, or missing deadlines—the project owner can file a claim against your bond. If your surety company determines their claim is valid, it will pay the agreed amount and seek your reimbursement.

By offering this financial guarantee, contract bonds build trust with project owners and encourage them to give you more projects, knowing you're supported by a dependable surety company.

What’s the Difference Between a Construction Bond and Insurance?

As a contractor, you may need to purchase various types of insurance policies throughout your career. General liability insurance, workers’ compensation insurance, and professional liability insurance are just a few examples.

Since surety bonds and insurance sound similar and both provide financial protection, it’s easy to confuse them. However, they differ in terms of:

• Who they protect – Construction bonds primarily protect project owners and government agencies. Meanwhile, insurance policies protect you and your business from various risks, such as accidents, property damage, or liability claims, helping you maintain your financial stability.
  
• Who bears financial responsibility – With construction bonds, you’re ultimately accountable for reimbursing your surety company for any claims paid out. In contrast, insurance companies reimburse you for covered claims.
  
• Their scope of coverage – Construction bonds only apply to one job at a time, so you’ll need to apply for new bonds with each project. Insurance, on the other hand, applies to all of your ongoing projects as long as your policies are active.

Five Types of Construction Bonds You Might Encounter

While all construction bonds are designed to ensure that you fulfill your obligations on a specific project, their scope and purpose can vary.

Here are five types of construction bonds you may need to purchase during your career:

1. Bid bonds – Bid bonds guarantee that you have the financial capacity to complete a project as promised. As a result, bid bonds discourage contractors from submitting frivolous or lowball bids. If you win a project but refuse to proceed with it, these bonds also ensure that the project owner can seek compensation for the costs associated with the re-bidding process.
   
2. Payment and performance (P&P) bonds – After winning a contract, you may need to secure a P&P bond. The payment bond ensures that your subcontractors, suppliers, and laborers are paid on time, while the performance bond guarantees that you’ll complete the project according to the contracts terms, budget, and deadline.
   
3. Development/subdivision bonds – If you work on land development projects, you may need to purchase a subdivision bond. Similar to performance bonds, these bonds ensure that you complete the project as specified. Local governments often require these bonds to ensure proper completion of public infrastructure work and to protect taxpayer contributions.
   
4. Maintenance/warranty bonds – Maintenance bonds guarantee that you’ll address any defects or issues that arise after a project is complete. If you don’t fix these problems promptly, the project owner can seek compensation from your surety to cover repairs related to your faulty workmanship. Having this type of bond assures project owners that you’ll stand by the quality of your work.
   
5. Supply bonds – Supply bonds guarantee that you’ll deliver the necessary materials or equipment for a project on time. If you fail to deliver or use substandard materials, the project owner can file a claim against the bond to cover any costs associated with supply replacements or subsequent project delays.

When Do You Need a Bond?

While you may purchase a variety of construction bonds throughout your career, they’re not required for every project. They’re primarily designed for those that involve significant risk or financial investment, such as: 

• Public projects – Most government contracts require bonds to protect public funds, with the Miller Act mandating that general contractors obtain P&P bonds for all publicly funded projects.
  
• Larger projects – Whether public or private, larger projects often require bonds to safeguard project owners’ investments. 

While construction bonds aren’t always required, having them can set you apart in competitive markets. Being bonded demonstrates that a surety company has assessed your qualifications and deemed you trustworthy and financially stable, giving project owners more confidence in your work. This credibility can enhance your competitive edge when pursuing larger clients and increase your chances of winning lucrative contracts.

How to Choose the Right Surety Bond Agency

Surety bond agencies help contractors identify and secure the surety bonds they need for various projects. Serving as a bridge between you and individual surety companies, they guide you through the application process and clarify your requirements. 

When comparing potential surety bond agencies, make sure to assess their:

• Industry experience – To get the best support, choose a bonding agency that has ample experience with construction bonds and understands what’s happening in the industry.
  
• Strong relationships with surety companies – A good bonding agency will have established connections with multiple surety companies. They’ll also advocate on your behalf to secure you the most competitive bond rates and terms.
  
• Excellent communication – Your bonding agency should act as your trusted advisor, outlining everything you need to know about your bonds’ requirements, costs, and timelines. They should also answer all of your questions and offer ongoing guidance and support.
  
• Transparent terms – A transparent agency should clearly outline its bonding process and various surety companies’ requirements. They should also be open about how premium costs and fees are calculated, ensuring you don’t face any surprises down the line.
  
• Reputation – You can vet various surety bond agencies by researching their track record with other contractors. Don’t be afraid to ask your agency for references. You can also check out their online reviews and client testimonials.

How Much Does a Construction Bond Cost?

While bonds have many benefits, you may be wondering what they cost. After all, you have salaries, supplies, equipment, and insurance to pay for, too.

 Construction bond costs vary wildly, ranging from a few hundred dollars to tens of thousands. Their premiums are set based on the following factors:

• Bond amount – Construction bond amounts are typically set by the project owners, government agencies, or regulatory bodies overseeing the project. On average, their premiums range from 0.5% to 3% of the total bond amount.
• Project size and type – Larger projects generally require higher bond amounts to protect owners’ investments, leading to higher bond premiums. Likewise, higher-risk projects, such as those involving significant public funds or complex regulations, often involve larger bond amounts.
•  Credit score – Similar to credit cards or loans, the cost of your bond premium is influenced by your credit score. A high credit score indicates that you’re a reliable borrower, giving surety companies more peace of mind that you’ll repay them promptly if a claim is filed. This may lead them to grant you a lower bond premium.
• Contracting experience – Lastly, your construction experience can impact your bond costs. Contractors with more experience typically enjoy lower premiums because they have a proven track record of successfully completing projects.
  

To secure the best rates, work with a surety bond agency that can obtain quotes from several surety companies before making your selection.

Bond Premium Calculation Example

Let’s say that you’re bidding on a large, public project with a bond requirement of $100,000. After reviewing your financial background and project history, your surety company sets your premium rate for this bond at 2%.

Using this formula “Bond Cost = Bond Amount × Premium Rate,”  the cost of your bond would be: 100,000 × 0.02 = $2,000. In other words, you would need to pay $2,000 to obtain this particular bid bond.

Tips for Increasing Bonding Capacity

Your bonding capacity is the maximum amount of bonds your surety company will extend to you at one time. Boosting your bonding capacity can help you secure larger projects and increase your profitability.

Here are eight ways to stretch your bonding capacity over time:

1. Strengthen your financials – Surety companies want to see that you have enough cash on hand to cover your expenses and any unexpected project costs. You can assure them by maintaining accurate financial statements and optimizing your cash flow.
   
2. Demonstrate strong project management skills – Surety companies prefer to partner with contractors who have a low claim risk. You can demonstrate that you are this type of contractor by consistently completing your projects on time and within budget.
   
3. Increase your access to credit – Having robust lines of credit can help you cover unexpected project expenses, reducing your perceived financial risk in the eyes of surety companies.
   
4. Vet subcontractors and suppliers with care – Your subcontractors and suppliers’ performance can impact your overall project success. Thus, it’s important to select ones who are bonded, insured, and unlikely to cause project delays or quality issues.
   
5. Improve your reputation in the industry – Surety companies consider your character and reputation when setting your bonding capacity. By networking with other reputable contractors and obtaining strong endorsements from clients, you can increase surety companies confidence in your reliability and professionalism.
   
6. Strengthen your relationship with your surety agency – Building a strong, transparent relationship with your surety bond agency can help you obtain better terms and higher bonding limits. You can cultivate this type of relationship by updating your surety agency on your project successes and business financials on a regular basis.
   
7. Request bonding capacity increases in advance – Rather than waiting until you need a higher capacity to reach out to your bond agent, let them know in advance that you would like to request a bonding limit increase for upcoming projects.
   

Conclusion

Navigating the world of construction bonds as a small to mid-sized contractor can be challenging on your own. With an experienced surety bond agency by your side, like BOSS Bonds, you can streamline the process and ensure you obtain the right bonds for your needs.

BOSS Bonds specializes in helping contractors like you secure construction bonds with competitive rates. With over 40 years of experience, our team is well-versed in the construction industry’s challenges and requirements. 

Most importantly, we’re dedicated to providing unparalleled customer service. Whether you’re a seasoned contractor or just starting out your career, well take the time to understand your unique needs and guide you through the bonding process, allowing you to focus on what you do best—delivering quality projects on time. 

Contact BOSS Bonds today to learn more about how we can help you succeed!