Payment bond definition: A payment bond is a surety bond issued to contractors that guarantees that the contractor will pay their subcontractors, material suppliers, and laborers in a timely fashion.

Payment bonds are usually obtained by contractors or subcontractors prior to the commencement of a construction project. Their function is to guarantee that the labor and materials provided by subcontractors and suppliers to a general contractor will be paid for in due time and in compliance with the contract. These bonds also guarantee that payments for labor and material will comply with state and federal laws and regulations.

Payment bonds serve as protection for subcontractors, and offer them legal recourse against contractors who do not fulfill their side of the contract terms. If a contractor has failed to pay subcontractors, suppliers and laborers can file a claim against the payment bond within a certain period of time, and receive compensation by the surety.

In other words, payment bonds are an agreement between the obligee requesting the bond (the subcontractor, supplier or laborer), the principal who obtains the bond (the contractor) and the surety bond company underwriting the bond.

Once a claim is initiated, the surety investigates, in order to decide whether any action must be taken. If the claim is legitimate, obligees can expect to be compensated for their losses up to the full amount of the payment surety bond.

If such compensations are made, principals– i.e. contractors– must compensate the surety for its coverage of the payment bond claim. That’s why contractors should always strive to avoid claims, and seek solutions to problems before they escalate.

Payment bond cost depends on the conditions of the contract you want to obtain a bond for. It is a percentage of the amount of the contract, which you have been awarded during a bid.

Your surety bond cost is a fraction of the total bond amount. This is called your premium.

When determining your payment bond rate, the surety will look at your financial standing. Your personal credit score is of great importance, because sureties use it as an indicator and predictor of financial stability. If you have a high credit score, you will be offered a payment bond at 1%-4% of the total bond amount.

If the contract you have won is worth $250,000 or more, the surety will look at your business even more closely. You will mostly likely be asked to submit personal and business financial records and further documentation about your business, your industry experience and more. Applying for such a bond usually takes slightly longer, due to the more extensive check performed by the surety.