Are Contractor Performance Bonds Really Necessary

Are Contractor Performance Bonds Really Necessary?

More often than not, you can hear someone sharing their unpleasant experience where they hired a person that turned out to be unreliable, did a sloppy and unsatisfactory job, went over the budget limits or the deadline, and so on. The most common method for avoiding such situations is through a performance bond.

What are performance bonds?

A performance bond is issued between a contractor and a client (sometimes referred to as an obligee), and usually there’s an insurance company or a bank acting as a mediator. The point of the performance bond is to make sure the contractor fulfills a job that was requested by an obligee. So, for example, say you want to build a house and you find a person willing to do that job for you. However, you want to make sure he uses the money you give only for building the house, so the two of you form a performance bond.

How Do Performance Bonds Work?

Let’s follow the mentioned example, and let’s say the house you want to build is worth $100,000. In most cases, here the contractor would reach out to an insurance company. Then, depending on these three factors:

· Bond type

So a performance bond in this case.

· Bond amount

In this case, $100,000

· Contractor’s risk

The reputation that a contractor has, along with his previous work and similar contracts that he fulfilled or didn’t fulfil.

Ultimately, the contractor will either fulfill the requirements stated in the performance bond or he won’t. If the contractor you found builds the house you want without a hitch, he gets the money and you get the house. If, however, he takes too long, spends too much money, or you get an unstable, unsafe or uncomfortable house, the insurance company will refund all the money you invested, which was stated as the bond amount.

This way, both parties are protected, and you will be assured that the work done would be exactly what you requested.  Here is a closer look at how they work.

How Much Do Performance Bonds Cost?

It depends on the final factor mentioned before – contractor’s risk. If the contractor is a well-known and widely respected constructor that already had deals with the same insurance company, they know that they won’t have to pay the refund, since he’s not likely to disrespect his part of the agreement. In this case it is usually requested from the contractor to pay around 0.5-1% of the total bond amount, and vice-versa, an unknown or first-time contractor would be requested to pay from 5% to even more than half the total bond amount.

Are Performance Bonds Really Necessary?

This mostly depends on what type of work you want done. For construction work, such as the example that we followed until now, it’s almost always necessary. If you’re dealing with other areas of work, or you’ve found a contractor that you personally know (a friend of yours, for example) and you’re sure he’ll fulfil his part of the agreement, you might want to bypass the performance bond process. However, in most cases, it’s better to be save than sorry.