Payment and Performance Bonds are the two types of Construction bonds often confused with each other. To get the basics right, one should know the basic difference between the two types of bonds.
A Performance Bond is a form of guarantee by the Surety Company, that a project will be completed according to the specifications mentioned in the contract. If the Principal fails to do so then it becomes the responsibility of the Surety Company to complete the project or have it completed.
The payment bond is a guarantee all the sub-contractors, workers, and laborers working on the project will be paid by the Principal.
These two bonds work in tandem to ensure a project is completed lien free. In many cases, both types of Bonds are required for construction projects. Sometimes, in rare cases, a payment bond may be required without the need of buying a performance bond. Bonding Companies generally offer Performance and Payment Bonds together so clients might pay one price for both types of bonds.
When applying, financial statements including balance sheets, income statements, cash flow statements, and a work in progress schedule with full disclosure are all required to complete the process.
A Performance Bond ensures the satisfactory completion of a project by the Principal in whose name the bond is issued. Generally these are used in public construction and commercial projects.
How do Performance Bonds Work?
The insurance or surety company issues a Surety Bond known as the Performance Bond. The contractor is known as the Principal who is liable to fulfill the contract according to its specifications. If the Principal fails to do so it becomes the responsibility of the Surety Company to complete the project or have it completed. Apart from Civil projects, Performance Bonds are usually required for projects in excess of $250,000.
How are Rates for Performance Bonds Determined?
The type of work, the estimated duration of the project, and the warranty on the work being done all go into determining the rate of the Performance Bond. Surety companies see many types of contacted work including excavation, concrete work, engineering construction, and architectural construction.
The overall credit worthiness of the contractor may impact the rate. The stronger the credit, the lesser the rate is likely to be. The Surety Company will look at many financial statements including balance sheets, income statements, cash flow statements, and a work in progress schedule when evaluating an application.