Performance Bond vs Letter of Credit

Bond Protection and Credit Impact (This One Matters)

Here’s where things get interesting – and where a lot of contractors get caught off guard.

Performance bonds don’t tie up your money. You pay a premium (usually 0.5% to 2% of the contract value), but your credit lines stay open. Your borrowing capacity? Untouched. That matters when you’re trying to grow your business or handle multiple projects.

LOCs are a different story entirely. The bank essentially freezes that money. If you need a $100K letter of credit, that’s $100K you can’t use for equipment, materials, or that next opportunity that comes along. We’ve seen contractors turn down profitable work because their credit was tied up in letters of credit from previous projects.

According to recent industry data, about 68% of construction companies report cash flow as their biggest operational challenge. Now imagine making that worse by choice.

I remember working with a contractor last year – let’s call him Dave – who had $200K tied up in LOCs across three projects. When a fourth opportunity came up (a really good one), he couldn’t access the credit he needed. Had to pass. Those were performance bond situations, but he’d gone the LOC route because “it seemed simpler.” It wasn’t.

This is where the philosophical difference becomes practical.
Surety companies don’t just write bonds and walk away. They monitor projects, sometimes visit job sites, and generally keep tabs on how things are going. If problems arise, they often step in to help solve them – because it’s cheaper than dealing with a claim later.

We’ve seen sureties help contractors find replacement subcontractors, provide technical expertise, even mediate disputes. They’re invested in project success.
Banks issuing LOCs? They check documents. That’s about it.

Your project could be falling apart, your client could be impossible to work with, your materials could be delayed for months – but if the right paperwork shows up at the bank, they’re paying out. No questions asked.

Contract Changes: Performance Bonds vs Letters

Contract modifications happen. Scope changes, timeline extensions, ownership transfers – it’s part of the business.
Bonds handle changes smoothly. Most modifications don’t require formal amendments to the bond. The surety bonds typically works with reasonable contract changes as long as they’re within the original scope and risk profile.
LOCs require paperwork for everything. Change the contract? Amend the LOC. Extend the timeline? More paperwork. Transfer ownership? Even more paperwork.
That administrative burden adds up, both in time and fees.

Payment Bond and Credit Cost Analysis

Bond premiums are pretty straightforward – typically 0.5% to 2% of the contract value, depending on your financials and experience. Better credit, stronger statements, solid track record? Lower rates. Performance bonds offer transparent pricing that reflects your actual risk profile.
Letter of credit fees are… messier. You’ve got issuance fees, commitment fees, utilization fees. Some banks charge upfront costs. Others hit you with ongoing fees. And that’s before considering the opportunity cost of tied-up credit. Bank guarantees often exceed 1% in total fees.
But here’s what really matters: when default situations happen.
With bonds, there’s an investigation process. The surety bond looks at whether you actually defaulted, whether the obligee has valid grounds for a demand, whether there are alternative solutions. It’s not automatic – and that protection shields you from frivolous claims. The principal gets due process before payment occurs.
Letters pay immediately when compliant documents arrive at the beneficiary’s bank. No investigation, no dispute process, no protection against questionable claims. The bank processes payment on demand without evaluating actual performance.

Choosing Between Surety Bonds and Letters

Go with performance bonds when:

• • You’re doing construction work (especially public projects)
  • Project completion is the main concern
  • You want to preserve borrowing capacity
  • You’re dealing with long-term contracts that might change
  • You want ongoing risk management support

Consider LOCs when:

• • • • You’re in international trade situations
      • Immediate payment is more important than performance oversight
      • The project is straightforward with minimal change risk
      • You’ve got plenty of available credit that you won’t need elsewhere

But honestly? For most Ontario contractors we work with, performance bonds make more sense. The cash flow preservation alone usually tips the scales.

Making the Switch Mid-Project

Can you change from one to the other? Sometimes.
We’ve helped contractors switch from letters to bonds when they realized the credit tie-up was hurting their business. It requires client agreement and usually some paperwork, but it’s doable if the numbers work. The owner and principal must agree to modify the underlying contract terms.
Going the other direction (bond to letter of credit) is less common but possible, though it rarely makes financial sense for the contractor.

Your Next Steps

Look at your current project pipeline. How many require guarantees? What’s your available credit looking like? Are you turning down opportunities because your borrowing capacity is maxed out?

If you’re consistently choosing letters because they “seem easier,” you might be costing yourself more than you realize – both in direct fees and opportunity costs. Each contract should be evaluated for the appropriate security instruments.

Here’s what we recommend:
First, get clear on what your projects actually need. Payment protection or performance assurance? Most construction work falls into the latter category where surety bond excel.

Second, gather your financials, contract details, and credit information. The better your documentation, the better your bond rates will be. Commercial surety companies reward well-prepared principals.

Third, get quotes for both options on your next project. See the real numbers side by side. Include all fees, consider the credit impact, and factor in the opportunity cost of tied-up credit. Compare how each affects your ability to take on additional work.

And honestly? Talk to someone who deals with both regularly. We’ve seen too many contractors make expensive mistakes because they didn’t understand the full implications of their choice. The wrong decision on security instruments can impact your business for months.

Ready to Step Up Your Game?

The guarantee you choose affects more than just that one project. It impacts your credit, your borrowing capacity, your ability to take on additional work, and how much protection you get when things get complicated. Whether you need a payment bond, performance bond, or letter of credit depends on your specific situation.
Most contractors we work with wish they’d understood these differences earlier. Don’t be one of them.

Secure the right guarantee for your project. Contact Roughley Insurance Brokers to compare performance bonds and letters of credit – so you protect completion and credit.

Schedule a call with our team, or reach out through our contact form. We’ll walk through your specific situation and show you the real numbers behind both options. Our team understands the nuances between surety bonds and bank guarantees.

Because choosing the right guarantee isn’t just about meeting contract requirements – it’s about positioning your business for growth. The right security instruments can make all the difference in your project success.

Note: This information is for educational purposes and general guidance. Every situation is different, so consider your specific circumstances and consult with qualified professionals before making financial decisions.