Construction Bonds

Construction bonds, also commonly referred to as contract bonds, are a type of surety bond, in which an issuing insurance company or bank guarantees a project completion by a specific contractor. In essence, a construction bond protects the assets of an investor that is in charge of a construction project, providing the legal contract necessary to ensure that hired contractors complete their jobs in a satisfactory manner based on predefined agreements. In other words, companies that fund construction projects usually apply for construction bonds from financial institutions like banks and insurance companies to ensure that their investment and project capital is not spent frivolously or unnecessarily on services that fail to meet their standards. For example, if a specific contractor were to abandon the job in the middle of the project, or perform shoddy, low-quality work that required the project owner/investor to spend additional funds on repairs, the total amount lost would be covered by the construction bond.

Types of Construction Bonds
There are three main types of construction bonds – bid bonds, performance bonds, and payment bonds. A bid bond, also referred to as a bid guarantee, is an insurance policy that is required for all federal construction projects that mandate a payment or performance bond. The bonds must hold a value of at least 20% of the total bid price, but cannot exceed $3 million. A performance bond is only federally mandated on contracts are worth more than $100,000, and lists conditions within the bond that give the project contractor an obligatory duty to report progress of work, payment history, and the estimated percentage of current completion when requested by the project owner or manager. Performance bonds help investors insure not only the total cost of the project, but also the quality and progress of the work being done. Payment bonds are also required for any contracts with a value of more than $100,000, however rather than providing coverage for investors and project owners, they are designed to help contractors, subcontractors, and suppliers guarantee payment for the work they have done.

Construction Bond Issuing Requirements
Construction bond issuing requirements vary depending on a variety of factors, including whether the issuing entity is an individual, and whether the project is part of a federal construction contract. Entities that attempt to fund construction bonds for profit must prove that they have the necessary amount of capital to support the total value of the bond, and they must have a collection of assets that can act as collateral in the event that the bond cannot be supported. Individuals are allowed to fund construction bonds in order to give contractors that are unable to be approved for corporate sureties the chance to qualify for some form of insurance for their projects. It should be noted that the funding and eligibility requirements for construction bonds is different for bonds that range from $25,000 – $100,000, than for those that govern bonds which exceed $100,000.

Construction Bond Eligibility Criteria
Each surety entity or company is allowed to create its own underwriting criteria and guidelines, however most companies consider the following criteria before approving an individual for a construction bond. First and foremost, the funding entity will want to ensure that contractor applicants have the skill, resources, and overall ability to perform the agreed obligation. Secondly, the bond issuer will want to ensure that the applicant is financially stable and capable enough to justify the risk of providing a bond. Finally, the bond issuer will check the work history, financial history, and credit history of the applicant to determine whether or not they are likely to complete the project and comply with the contract terms.

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