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Understanding Different Types of Builder Contracts: Exploring the Pros and Cons

When it comes to the construction of your custom home, the builder contract serves as the cornerstone of a successful project. This agreement establishes the terms, conditions and obligations between you, the homeowner, and the builder. It provides a roadmap for the entire construction process. There are two uniquely different types of contracts in construction, and each has their unique place. We will define each of these, while also examining the residential builder contract pros and cons to shed light on the agreements.



Builder Contract

Fixed Price Contracts

In a Fixed Price Contract, which is also referred to as Lump Sum Contract, all work is completed for a stipulated, specific amount of money, no matter how much it costs the builder to perform the work. The homeowner knows they will get the custom home they desire for a certain amount of money and there are no surprises. Usually, the work is billed as it progresses on a percent complete or milestone basis. The Fixed Price Contract is used quite often for custom home construction. Here are some of the pros and cons for the homeowner with this contract type.


Pros

  • Budget Certainty: Fixed-priced contracts offer precise cost estimates, providing homeowners and their lenders with budget certainty from the start of the project.

  • Risk Mitigation: Builders assume the risk of cost overruns, incentivizing them to control expenses and adhere to the budget.

  • Simplified Budgeting: Homeowners find it easier to plan their finances and cash flow as they know the exact project cost and have a good idea for when payments to the builder will be required beforehand.


Cons

  • Limited Flexibility: Changes in project scope can lead to additional charges via change orders, making it challenging and costly for homeowners to alter plans mid-construction.

  • Higher Cost: Since the builder assumes the risk, additional contingency and/or margin will be included within the costs for this type of contract.

  • Risk Transfer: The risk of unforeseen circumstances, such as material price hikes, can in extreme circumstances be difficult for less financially stable builders to complete the home.


cost plus contract

Cost Plus Contracts

This contract type is also referred to as a Time and Materials Contract. In a Cost Plus Contract the builder is reimbursed for the job costs plus a markup which is normally a percentage of the costs. Work is billed on a regular basis (e.g., weekly, bi-weekly, monthly) as it is completed. Each bill may be accompanied by proof of expenses through paid invoices for the material and labor. Again, there are pros and cons for the homeowner with this contract type.


Pros

  • Transparency: Homeowners have a clear view of all the projects’ costs, including materials, labor, builder overhead and builder profit, which promotes transparency.

  • Flexibility: Homeowners can make changes to the project scope more easily and knowing how the additional costs will be handled, accommodating projects that have evolving requirements.

  • Lower Costs: Since the risk is on the homeowner, unused contingency or any actual costs below the original estimate benefit the homeowner.


Cons

  • Budget Uncertainty: Since the final cost depends on the actual expenses, homeowners may face budgetary uncertainties, especially if costs escalate unexpectedly.

  • Risk Transfer: Any unexpected costs above the estimate will be the responsibility of the homeowner.

  • Potential for Disputes: Disagreements may arise over costs that are due to errors or mistakes.

  • Billing Complexity: Since each bill may be accompanied by paid invoices, these tend to be complicated and irregular amounts. Some months may be very high amounts while others are low depending on what stage the project is at.


Conclusion

To wrap up this discussion, choosing the appropriate builder contract is a pivotal decision that profoundly influences a custom home project’s outcome. Fixed Price Contracts offer budget certainty, but limit flexibility, while Cost Plus Contracts provide transparency, but can lead to budget uncertainty. Ultimately, the selection of the builder contract should align with the project’s specific requirements, balancing the need for cost certainty, flexibility, and quality. Homeowners and builders must engage in open communication, clearly defining expectations and responsibilities to mitigate potential issues and ensure a successful project. By understanding the nuances of each contact type, you can make an informed decision, laying a robust foundation for your custom home.



Additional Resources

  • NAHB - A link to the National Association of Home Builders contracts page

  • Legal - Some legal tips of what to look out for in a builder agreement

  • More Legal - Additional legal advice re contracts

  • Owner's Rep - Link to an article about expert 3rd parties and how they can assist

  • Video - A video explanation of the contract options

Comentarios


“I have known Jon for many years. He and his team at Owners’ Ace are an invaluable resource to anyone looking to design and build a custom home. Having their assistance makes a complex process so much easier and successful. I recommend Owners’ Ace to my clients and to anyone looking to build their dream home.”

BG Holmberg, Top Custom Home Realtor in Tampa Bay Area

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