Contractor license bonds: How to determine cost

Some licensing authorities require that plumbers file a surety bond before they can be legally licensed. Licensing regulations vary by jurisdiction, of course, so plumbers should always check with the local government agency that regulates licensing to determine specific requirements. Plumbers who need a bond to comply with state or local laws should understand the factors that affect their bond premium. The following is a quick guide that explains what those factors are and how you can use them to estimate your bond’s cost.

Application type

A critical determinant of a bond’s premium is whether the bond is instant issue or credit-based. Instant issue bonds are sold by surety providers for one low, flat rate. These bonds are generally not very risky and have fewer claims filed against them.

Everyone qualifies for these bonds, and personal financial information is usually not needed to qualify. These bond amounts usually range from $1,000 to $15,000. On the other hand, credit-based bonds require underwriting. Underwriting is the process of reviewing the applicant’s financial information and work experience to determine a premium. These bonds can be more expensive and more difficult to qualify for than instant issue bonds, typically because the risk is greater. That said, contractors with good credit scores and a clean work history can expect to qualify for the industry’s lowest available rates.

Bond amount

For credit-based bonds, the bond amount will affect the premium the applicant pays as premiums are calculated as a percentage of the total bond amount. Most license and permit bond rates are calculated at 1 percent to 20 percent of the bond amount. For example, if an applicant’s bond amount is $10,000 and the rate is three percent, the premium would be $300. However, if the applicant’s bond amount is $20,000 and the rate is three percent, the premium would be $600. Bond amounts are determined by the obligee, typically state and local governments, and vary according to the risk and number of issues within the industry.

Personal credit score

Credit-based bonds require applicants to undergo to a review of their credit report. As one could expect, better credit scores typically result in better rates and vice versa. For example, an applicant with a great credit score could expect a one percent to three percent  rate on a $10,000 bond, which equates to a $100 premium. In contrast, an applicant with a poor credit score can net a ten percent + rate on a $10,000 bond, which equates to a $1,000, plus premium. As the bond amount increases, an applicant’s credit score gains significance because the premiums vary greatly between rates.

Work experience

Some underwriters place more value on work experience than others, but nonetheless a contractor’s experience in the industry can factor into the bond’s premium. If a plumber has a long history working in the industry without major financial or work-related blemishes on his or her record, the premium could be lower than it would be for brand new businesses. Depending on the underwriter, plumbers with reliable histories can be viewed as carrying less risk and thus can qualify for lower bond premiums.

Contract bonds vs. contractor license bonds

An important distinction must always be made between contract bonds and contractor license bonds since many people incorrectly use the two terms interchangeably. The bonds plumbers typically need are contractor license bonds that are required before a contractor can be legally licensed. These bonds have been the focus of this essay.

A contract bond, on the other hand, ensures that a specific contract for construction project will be completed according to the legal terms. Plumbers might need to secure this type of bond before being awarded a large plumbing project for a school or hospital, for example. There are many different types of contract bonds, but they almost always have much higher bond amounts and are much more difficult to qualify for. Contract bond applicants must have a good credit score and strong business and personal financials to qualify.

Surety bonds exist to help protect the state and consumers from unlawful and fraudulent business practices on behalf of contractors and other principals. Although they incur another cost for plumbers, they help reinforce industry integrity and increase business marketability. Contractors can find more information about contractor license bonds with this useful resource.