Understanding the Different Home Building Contracts
Which home building contracts are right for your new home?
There are different types of home building contracts that a builder and owner may enter into in getting their house built. The size and customization of the home being built, site conditions, owner participation and other factors may determine the most suitable type of contract that is best suited for your project. Remember that the reasons these different contracts exist are for the benefits of both the builder and the owner. The most important thing to remember in trying to decide what type of contract to consider with your builder is that which one is going to get my house built, the way I want it built, for a fair price while the builder makes a fair profit for his/her services.
Fixed Price Contract
This is the most common contract done between builder and owner. It is so for a couple of reasons.
1) The owner is most comfortable knowing that the price of construction is fixed.
2) Lenders like fixed contracts so they know the project is not going to go over budget.
1) From the builder’s side, this type of contract is the most risky in that the builder must be very accurate in it’s estimating. Any miss calculations in the actual construction cost or material price increases comes out of the builders profit.
2) From the owner’s side, some builders may put in extra contingency fees to cover any possible miscalculations, price increases or their lack of being a good estimator. If these extras are not needed in the project then the builder would end up making more profit on the job and the owner may have paid too much.
Cost Plus % Contract:
This is the second most common type of home building contract. This can be a great type of contract for homeowners and builders. It is great for large or complicated projects that are very hard to estimate the actual cost or where the client wishes to not make most of their specifications decisions up front where the builder can accurately estimate it. The advantages and disadvantages are listed below.
1) Full Disclosure: The owner gets to review all of the expenses of the entire project. Typically monthly statements are given to the owner with actual invoices for all expenditures. This gives the owner tighter control of the associated cost. Most builders do not want the owner to play in selecting suppliers and subcontractors, but provide financial statements.
2) Less risky for the builder: The builder is paid a % of the associated cost for overseeing the project, so any cost overruns does not come directly out of the builders profit as in fixed price contracts.
3) Flexibility: Some home building projects are highly custom or the owner wishes to make slower decisions along the way or make a lot of changes along the way. This type of contract is better in providing that flexibility. Remember though time/changes cost money.
4) Cost: It is possible that the project could actually cost less under this type contract depending on the circumstances.
1) Cost: The owner is much more prone to go over budget, because of the high flexibility issues. It opens the door to the owner to research out the 120,000 plus building products on the market today, and most of these non standard building materials are much higher in price than the builders standards.
2) The builder is incentivized to spend more money. The more project cost the more money the builder makes. It is especially important that there is a high trust between the builder and homeowner in this type of contract.
3) Accounting: Extra time is spent by the builder preparing the monthly statements for the homeowner, copying invoices, etc.
Cost plus % fee, not to exceed Contract
It is also common to have a contract as mention above with a cap on the “top in” to give the homeowner all of the benefits that a cost plus contract offers with the insurance that the project will not exceed a certain cost point.
Special Note: It is common for builders to either charge for an allocation of their overhead to your project or to bill you for meeting times, supervisory times. For example, one builder may give you a cost plus 22% fee schedule for handling the project with no overhead allocation. The next builder may give you a cost plus 8% fee schedule, but bill you for all expenses incurred by his/her staff members relating to your project including, but not limited, to meeting times, accounting, copies, cell phone use, travel, supervisory, etc.
Cost plus Fixed Fee Contract
This is not a common type of contract, but works very similar to the cost plus % contract, except it is a flat fee. For example, the owner agrees to pay the builder a fixed fee to build a home expecting to cost around $250,000. All of the other advantages and disadvantages of the cost plus listed above apply, except the builder goes back to a riskier environment if the project takes a long time to complete and more overhead has to be dedicated to get the project done than he/she estimated.
Which contract is best for Me? If you can make most of your selections up front, the “fixed price” contract is the safest from a homeowner standpoint. If your project is highly custom I would lean toward the “cost plus” type contract.
Final Note: More importantly than the type of contract you end up choosing is your relathionship with your builder. Are you comfortable with his/her personalities? How are their references? Does he/she conduct business professionally?
About HomeSource Builders:
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This document reflects the opinion of Tim Alexander, a licensed General Contractor in the Asheville, NC area.