Five Myths About Payment Bonds And The Truth Behind Them

One type of supply contractor bond is a payment bond. A payment bond is related to paying subcontractors on a job, and if you've just gotten a contract for a project, you may be required to take out a payment bond through a company like Service Insurance Company. There are several myths and misconceptions that float around about these bonds, and before getting one, you may want to know the truth behind the following myths.

1. Myth: Payment Bonds Are the Same as Performance bonds

A performance bond is a guarantee that you will complete the job as requested by the client, but a payment bond is not related to how you complete the job. Instead, a payment bond only covers paying subcontractors or suppliers who help you with the job. These are two different bonds, and you may be required to have both of them. Luckily, in many cases, you can purchase these bonds together from a company that provides contractor bond services.

2. Myth: You Can't Get Payment Bonds With Poor Credit

The truth behind this myth is that it can be challenging to get payment bonds when you have poor credit. In particular, bad credit doesn't necessarily preclude you from obtaining a payment bond, but it can drive up the price of your premiums.

To get a payment bond easily when you have poor credit, you may want to look for a contractor bond services company that works with contractors with bad credit. Alternatively, you may want to work with a certified public account and make sure that all of your accounting and financial records are accurate and well organized. In many cases, bond companies want to examine your financial state before issuing the bond. That gives these companies the reassurance that you can repay the bond issuer if someone makes a claim on your bond.

3. Myth: You Only Have to Pay for a Payment Bond If Someone Makes a Claim

Regardless of whether anyone makes a claim on your bond or not, you still have to pay for the bond. Here's how it works. Typically, you take out a payment bond for the estimated value of all the money you are going to pay to subcontractors and suppliers throughout the duration of the project. The price of the bond is typically a small percentage of this total amount. The percentage is your premium, and you have to pay that amount no matter what.

4. Myth: If Someone Makes a Claim, They Automatically Get a Payment

If a subcontractor or supplier feels that you have not paid them for their work, they can submit a claim to the bond services company. However, the bond issuer doesn't just pay out automatically. Rather, the company looks over the claim to ensure it is valid. If the company judges the claim to be valid, it pays the claimant. Then, it holds you responsible for the payment.

5. Myth: All Subcontractors Are Covered by Payment Bonds

In truth, when a contractor takes out a payment bond, that covers most of the subcontractors on the job, but it doesn't cover all of them. Only first and second tier subcontractors can make claims. Third tier subcontractors are not allowed to make claims.

To explain, imagine you are the head contractor on a job, you hire an electrical contractor, and he or she in turns hires some subcontractors to do the wiring. In this case, the electrical contractor is a first tier subcontractor and his or her subcontractors are second tier contractors. All of these individuals are covered by the payment bond. However, if those second tier contractors hire subcontractors, those individuals are not covered by the payment bond.