Is Your Contractor Bonded, Licensed, and Insured — And Why Does It Matter?

Your neighbor may be a great person who is handy and willing to work on the cheap just to be helpful, but they are no substitute for a licensed, bonded, and insured contractor for big jobs around the house. Consider what happens if your neighbor — skilled as they are — makes a mistake that results in damage to your property. There is no guarantee they will pay to repair the damage they caused.

That's just one reason for choosing a pro over your neighbor, someone else's neighbor who was recommended on social media, or someone you met at a lumberyard. Think about what would happen if you have a plumbing leak fixed by a neighbor or acquaintance — or a handyman you find on Craigslist —and the repair fails, creating an emergency situation. There's no guarantee that your neighbor or any other handyman will be willing to fix the issue, and you're on the hook for the cost of the repair. This is not so if you hire a licensed and bonded pro.

Besides being bonded, professional contractors usually carry liability insurance to protect them in case of accidents while working. If you hire someone without this protection and an accident happens on your property, you could be liable, and medical costs could come out of your homeowners' insurance, resulting in a premium hike.

So, what exactly does it mean to hire a contractor who is licensed, bonded, and insured? Here's what you need to know before you sign a contract.

When a contractor specializing in home repair advertises that they are licensed, bonded, and insured, they are making three separate claims.

A licensed contractor is deemed by relevant building authorities to be competent to perform the requested services and usually has to pass an exam. Not all general contractors have to be state licensed — some states defer to local building departments for licensing requirements — but specialty tradespeople, such as electricians, plumbers, and HVAC technicians, generally require state certification.

If you happen to live in New Hampshire, for example, the general contractor who lays the concrete slab for your outdoor kitchen patio does not need a state license, but both the electrician who installs the outdoor lighting and the plumber who hooks up the outdoor sink do. In California, all three contractors need state licenses to legally do their jobs, but in New York, none of the contractors need state licenses, although they may require licenses from the municipalities in which they work.

In terms of helping homeowners breathe easier when working with contractors, bonding is even more important than licensing because it provides protection against poor workmanship or failure to complete a job as contracted. The bond that guarantees this is called a performance bond — a type of surety bond issued by an insurance company. The contractor pays a yearly fee for a surety bond. States that require licensing for contractors typically also require them to be bonded.

Payment of the bond fee provides access to a lump sum — usually from $10,000 to $15,000 — in cases of a breach of agreement or substandard workmanship. To access this sum, an aggrieved homeowner has to file a claim, and if the claim is successful, the contractor is liable to the surety company for reimbursement of the payment.

Although bonding sounds like insurance, it isn't the same thing. Whereas the purpose of bonding is to protect the homeowner, insurance mainly protects the contractor. It provides coverage for business-related liability exposure and isn't a licensing requirement. Although insurance mainly benefits the contractor, a homeowner can file a claim in cases in which damage expenses exceed the bond amount.

A bonded contractor usually has a performance bond that applies to the specific job the contractor contracts, but that isn't the only possible kind. Depending on the size of the construction project, a payment bond may also be required. This type of contract bond guarantees that materials suppliers, subcontractors, and supporting services (like cleaning companies) are paid in full. The bond covers defaults by the contractor and prevents actions against the homeowner, such as property liens or third-party billing. Related bonds include these types:

• ​Contractor license bonds​, which are a combination of performance and payment bonds, are usually required by states that issue contractor licenses. Minimum bond amounts vary by state. In California and in other places it's $15,000, but it can be as low as $1,000 (New Jersey) or as high as $20,000 (Oregon). In some states, minimum bond amounts are determined by local authorities.
• ​Supply bonds​ are similar to payment bonds, but their main purpose is to ensure that all the supplies and materials required for the job as specified in the work contract are provided. Suppliers as well as contractors obtain these bonds.
• ​Warranty bonds​, also known as maintenance bonds, guarantee workmanship for a specified period after a job has been completed. If anything goes wrong during the warranty period, the homeowner can file a claim against the bond as reimbursement for any necessary repairs, even if the repairs are completed by a different contractor.
• ​Ancillary bonds​, such as subdivision bonds, may be required when contractors make changes to public property as part of a project. An example would be cutting through a sidewalk to fix a broken sewer. Bid bonds are common for large construction projects. They provide assurance that the winning bidder delivers materials and services as specified in the bid.

A contractor takes out an insurance policy for the same reasons anyone else does: to guard against financial ruin from accidents and the resulting remediation and legal expenses. Contractors with employees typically have workers' compensation policies to cover the costs of employee accidents in the workplace, and they also have liability insurance to cover losses from claims made against workmanship or materials defects that cause injury or damage.

Liability insurance covers personal injury, property damage, and loss of use expenses as well as legal fees incurred as a result of work performed by a contractor observing proper procedures. It doesn't, however, cover employee injuries, which is why contractors with multiple employees also have workers' comp insurance. An example of a scenario in which a homeowner could file a claim against a contractor's insurance policy would be if an electrician installed a faulty electrical device without knowing it was faulty, and it failed and caused a fire, resulting in tens of thousands of dollars of damage.

If you have a job that's more complicated than painting a shelf or fixing a toilet, stay on the safe side and look for a bonded and insured contractor to handle the job. In states in which licensing is required, you'll want to know the contractor's license number. Many contractors advertise their number on their vehicle and are happy to supply it to you if they don't. The license number is valuable because it gives you access to bonding and insurance data.

In California, for example, you can search the license number on the state contractor's board website, and the search will return the contractor's bond number, the bond amount, and the name of the surety company that underwrites the bond. You'll be able to see at a glance whether the contractor or the contractor's business (if the contractor is a business owner) meets the bond requirements for the state, and you'll even get a complete bond history for that contractor. You'll also see what type of insurance policy the contractor holds.

Not all states and municipalities are as organized as California, but if licensing is required, you should be able to search the license on the website for the relevant licensing board. The information you find there isn't a substitute for references from friends and past clients, but it provides assurance of the contractor's credentials. Beware of contractors with out-of-date licenses, outstanding bond balances, lapsed bond payments, or insufficient insurance coverage, any of which could put you on the hook financially if something goes wrong.

First, be sure to get all the details of the job you're contracting in writing before the contractor starts the job. The contract should specify every detail you consider important, including the expected finish date and the agreed-upon cost of the project. This document will be ultra important if it becomes necessary to file a claim. You can file a claim without it, but your chances of success aren't as great.

The claim process starts with finding the name of the surety company that underwrote the bond and sending it a preliminary letter indicating your intention to file a claim, including a copy of the contract and other documents and pictures that support your claim. The company will send you more documents to fill out and ask you for an official written statement and other information it deems necessary. When you send back all the necessary documentation, the company will evaluate your claim and determine whether or not it owes you money. Don't hold your breath waiting for a quick reply, however; it could take weeks or months.

If you aren't satisfied with the decision of the surety company, you can file a complaint in the superior court or in small claims court in the county in which the work was done or in which the contractor is active. There's a time limit for filing such complaints — two years from the time the contractor left the job is typical, although it varies by state — and you must provide written notice to the contractor of intent to sue well before you file (45 days is typical) to provide the contractor an opportunity to correct the problem. The filing process is detailed and is best handled by a lawyer.