Types of Bonds in Construction Explained

Winning a major construction contract feels like hitting the jackpot until you realize the project owner requires a bond. For many contractors, especially those moving from smaller residential projects to commercial or government work, bonding requirements can seem like an unnecessary barrier. Understanding the different types of bonds in construction and how they function removes the mystery and helps you prepare for larger opportunities.

Construction bonds aren’t insurance for your company. They protect project owners from financial loss if you fail to complete the work as promised. Think of them as a financial guarantee that backs up your commitment to deliver the project according to contract terms.

What Construction Bonds Actually Do

Construction bonds, also called surety bonds or contract bonds, involve three parties working together. You purchase the bond as the contractor. A surety company issues the bond after evaluating your financial strength and track record. The project owner receives protection if problems arise during the project.

These bonds are required for virtually all public works projects and many private construction contracts. Federal law mandates certain bonds for any contractor bidding on federal contracts valued at $150,000 or more. Many states have similar requirements for large state-sponsored public works projects.

The surety company doesn’t just hand you a bond because you asked nicely. They investigate your company’s finances, review your experience with similar projects and examine your current workload. This underwriting process determines whether they’ll issue the bond and at what cost.

Surety companies offer several types of construction bonds, each with different uses. The various types of construction bonds include:

• Bid bonds
• Performance bonds
• Payment bonds
• Maintenance bonds
• Supply bonds
• Subdivision bonds
• Site improvement bonds. 

This article will cover four of the most common types of construction bonds.

Bid Bonds Prove You’re Serious

Bid bonds come into play during the proposal phase before you win any work. When you submit a bid on a project, the bid bond tells the owner you have the financial capacity and intent to actually complete the project if selected.

Without a bid bond, owners have no protection against contractors who submit unrealistically low bids, win the project and then walk away when they realize they made a mistake. The bid bond amount typically equals a percentage of your total bid, often 5% to 10% of the project value.

If you win the bid but refuse to sign the contract or can’t obtain a performance bond, the owner can claim against your bid bond. The claim covers the cost difference between your bid and the next lowest bid or the expense of re-bidding the entire project. This financial consequence keeps contractors honest during the bidding process.

Performance Bonds Guarantee Project Completion

Once you win the contract, the bid bond ends and a performance bond takes over. This bond guarantees you’ll complete the project according to contract specifications, on schedule and within budget. Performance bonds typically equal 100% of the contract value, providing owners with complete financial protection.

The surety company maintains an active interest in your project once they issue a performance bond. They monitor progress to ensure you’re meeting milestones and staying on track financially. If serious problems develop, the surety steps in before the situation becomes catastrophic.

If you default on the contract, the owner files a claim against the performance bond. The surety then has several options: provide financing to help you complete the project, hire another contractor to finish the work or pay the owner for their financial losses. Either way, you remain ultimately responsible for reimbursing the surety for any money they spend resolving the claim.

Payment Bonds Protect Your Subcontractors

Payment bonds guarantee that subcontractors, suppliers and laborers get paid for their work and materials even if you face financial difficulties. These bonds typically accompany performance bonds and equal the full contract value.

Payment bonds matter because they keep projects moving forward without interruption. When subcontractors know a payment bond protects them, they’re more willing to work on the project. Without this protection, unpaid subs might file mechanics liens against the property or simply stop working.

If you fail to pay a subcontractor or supplier, they can file a claim directly against the payment bond. The surety investigates the claim and pays valid amounts owed. You then must reimburse the surety according to your indemnity agreement. This structure protects everyone in the payment chain from the owner down to individual laborers.

Maintenance Bonds Cover Post-Completion Issues

Some projects require maintenance bonds, also called warranty bonds, to cover defects that appear after completion. These bonds typically remain active for one to two years following project acceptance, though terms vary based on contract requirements.

Maintenance bonds protect owners from faulty workmanship or defective materials that only become apparent after the project wraps up. If covered defects appear during the warranty period, the surety ensures repairs happen without additional cost to the owner. This gives owners confidence that their investment remains protected even after you leave the job site.

The cost of maintenance bonds is generally lower than performance bonds because the risk decreases substantially once a project passes final inspection. However, they add another layer of accountability that benefits everyone involved.

Understanding Bonding Capacity

Your bonding capacity determines the total value of projects you can bond at any given time. Surety companies set this limit based on your financial strength, experience and current workload. Understanding your capacity helps you bid appropriately and avoid overextending your company.

If you tie up most of your bonding capacity on one large project, you might not have enough capacity left to bid on other opportunities. Smart contractors manage their bonding relationships carefully and work to gradually increase their capacity as their business grows and their financial position strengthens.

Working with surety professionals early in your growth plans helps you understand what steps you need to take to qualify for larger bonds. This might include strengthening your balance sheet, improving your financial reporting or gaining experience with progressively larger projects.

Build Your Bonding Future

Understanding the different types of bonds in construction positions your company to compete for larger, more profitable projects. Each bond type serves a specific purpose in protecting project owners while demonstrating your capability and commitment as a contractor.

Strong financial management and accurate reporting form the foundation of bonding capacity. Surety companies want to see clean financials, consistent profitability and effective project cost controls before issuing bonds. Building these systems now prepares your company for future growth opportunities.

We help construction companies develop the financial infrastructure needed to support bonding capacity and project growth. From implementing proper job cost accounting to producing financial statements that satisfy surety requirements, we understand what it takes to build bonding relationships that open doors. Contact a James Moore professional to discuss your construction accounting and bonding needs.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.