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A payment bond is a type of guarantee. A contractor obtains a payment bond in order to guarantee that he will pay those who supply him with labor and materials on time and in the full amount to which the parties have agreed. A contractor usually has to pay a premium on a payment bond. The amount of the premium may vary, depending on the value of the project and the contractor's credit history. In many cases, payment bonds are issued at the same time as performance bonds, which serve to guarantee that the contractor will perform the work to which he has agreed.
When a contractor takes on a project, he may need the help of laborers and subcontractors to complete it. He will typically need supplies and materials as well. Contractors do not usually pay laborers and subcontractors prior to beginning the work. In some cases, they may defer paying for materials and supplies until after the work is completed as well. If the contractor fails to make payment as agreed, this is referred to as defaulting. A payment bond guarantees against contractor default.
Payment bonds can be compared to insurance in that they provide coverage when something goes wrong. Often, however, insurance benefits the purchaser while bonds protect others besides the purchaser. Essentially, payment bonds encourage people to do business with a contractor, as they take on less risk when a payment bond is secured.
Usually, a contractor who needs a payment bond pays a premium for it. For example, he may pay a 5 percent premium on the bond amount. The premium amounts for these types of bonds vary, however, and often depend on the contractor's credit history and the worth of his assets. Generally, a person with a lower credit history and fewer assets will have to pay a higher premium for a payment bond.
In many cases, payment bonds are issued along with performance bonds. These bonds are also used to guarantee a contractor’s actions. In this case, however, the bond does not serve to protect the laborers or material suppliers. Instead, it is used to guarantee that the contractor will complete the project work as expected.
Payment bonds are often used on construction projects. They may be used for projects of all sizes, though they are particularly important for large projects that involve a significant financial investment. The same goes for performance bonds.