Construction Loan Center

Why Fixed Contracts Make Sense

When building a home, you will be confronted with various contracts from contractors. Some will be detailed and others ambiguous. The challenge is carefully..

A cost-plus contract is the most ambiguous contract you will encounter. This term means the contractor agrees to supply labor and materials for a specified amount, with any additional services being added. This type of agreement leaves the price open to circumstances encountered by the builder. For example, an excavator may quote $9,000 to grade your building lot. But say there is a large tree which requires extra digging to be removed. He will charge the base price of $9,000 plus the cost of removing the roots. The cost of removing the tree may be minimal, but coupled with any other surprises (such as rock, importing or exporting of dirt, etc) and the $9,000 bill can quickly double. Some contractors prefer this type of contract because it relieves them of sticking to a set price. Obviously, hauling away dirt, stumps, etc., is going to cost the contractor more money. However, he passes this cost along to you – the homeowner. This also means he does not have to be as accurate in his initial bid because any extras will be passed on.

A cost-plus contract is the riskiest type of contract to sign. You may be handed a bill twice the cost of what you agreed to initially. When working with a fixed budget, this can mean disaster. If you sign this type of agreement, you have to hope that no unforeseen circumstances are encountered by the contractor. However, in construction, surprises are a part of the business. Construction would not be construction without surprises!

The more favorable contract is one with a fixed cost. This means the contractor will supply all labor and materials for "x" amount of dollars. If he missed something on the plans and it ends up costing more, he has to absorb the cost. This puts responsibility on the contractor to be detailed in his bidding - because after all, he is in business to make money. This type of agreement protects you from contractors looking to take advantage of unsuspecting homeowners.

Do not be surprised if you find a price variance between fixed and cost-plus contracts. A cost-plus contract will typically be lower than a fixed cost bid. The contractor wants to protect his profit, time and energy, so he will typically bid a fixed contract higher (to guard against mistakes). Whereas with a cost-plus contract, he may be more apt to bid low, knowing he can charge more if unforeseen circumstances arise. Homeowners often settle on the lowest bid as a way of saving money. But in the long run, a cost-plus contract may cost you more than a fixed price.