Contractor License Bonds
Many government agencies require construction professionals to purchase contractor bonds before they can legally begin work on construction projects in certain jurisdictions. Because these bonds are often required before a contractor can secure a contractor license, they're also known as contractor license bonds.
Unfortunately, construction professionals usually don't know much about getting contractor license bonds. For example, new contractors might not realize they have to pass a financial review before a surety provider will issue them a contractor bond. Having a basic understanding of contractor bonds make the process easier and more pleasant for contractors.
How a contractor license bond works
Contractor license bonds are a specific type of surety bond, which means that each contractor license bond that's executed acts as a three-party contract to help guarantee a certain quality of work. When it comes to contractor license bonds, the three parties include:
- the principal, which is the contractor that buys the contractor license bond to guarantee that licensing regulations will be fulfilled appropriately
- the obligee that requires the contractor license bond, which is typically a government agency such as a state's licensing board
- the surety that executes the contractor license bond as a financial guarantee that the contractor will adhere to licensing regulations
Why contractors need contractor license bonds
The primary purpose of contractor license bonds is to protect consumers from unqualified contractors. As such, contractor bonds provide a legal financial guarantee that construction professionals will follow all applicable licensing regulations related to a project. Each contractor bond that's issued is unique in that its protection is dependent upon the bond's exact contractual terms. Government agencies that require contractor bonds work to regulate the industry, cut down on fraud and, of course, keep unqualified contractors out of the construction industry.
Contractor license bonds are not insurance policies
Surety bonds are often confused with insurance policies, but it's important to remember that they are a completely separate product. Whereas an insurance policy typically protects the policyholder's interests, a surety bond protects the customer's. In fact, if a claim is ever made against a bond, the contractor will be responsible for paying the claim.
How to get a contractor license bond
Since surety bonds are a form of credit, purchasing a contractor license bond is similar to getting approved for other forms of credit. Contractors must undergo an application process, pass a credit check and prove they are financially stable. Some surety providers might also consider a contractor's performance on past construction projects.
The surety will also establish a bonding capacity for the contractor. There are two types of bonding capacity, and each involves limits that contractors must abide by.
- A single bond capacity limits the cost of an individual job that a contractor can work on. Every project a construction professional is contracted for must be less than this amount.
- An aggregate bond capacity limits the total monetary amount of work a contractor can perform at once. This amount can potentially be dispersed over many jobs.
Contractor license bond costs
Rates for contractor license bonds vary for a number of reasons, as sureties calculate premiums based on a contractor's credit score and other financial credentials. Contractors who have low credit scores will pay more for their contractor license bonds because surety providers take a risk when backing financially unstable principals. Contractors with good credit should expect to pay a premium that's about 5% of the bond's penal sum whereas those with poor credit could pay up to 20% of the bond's penal sum.
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