I’ve been doing residential construction loan lending for over 30 years now. Until the last few years I rarely had a builder that insisted on a Cost Plus contract. Now I see them frequently and it’s a problem.
A Cost Plus contract is different from a Fixed Price contract. It’s more of an employment contract and not a promise to build at a fixed price. The builder is stating that they are uncertain of the cost to build. They will instead offer an estimate to build but then state that they are simply charging the homeowner the cost of materials, labor and fees and adding their profit of 8%, 10% or whatever they want to make on the project.
It’s a great deal for the builder. They guarantee themselves a profit on the project regardless of what it actually costs to build the home and have little incentive to get the best deal for their client. It’s a bad deal for the homeowner. They have no recourse if the project ends up costing more than what they planned for or were approved for with their lender. That can end up being a really, really, big problem. Even if the homeowner is re-approved for a higher loan amount, the lender may charge the same fees to the homeowner that they paid on the original loan. It would be a whole new loan and would take time to close.
Understand that the worst thing that can happen with building a new home is that you run out of money before the home is completed. Mortgage lenders do all they can to make sure that this never happens, which is why most of them will not accept a Cost Plus contract. If this does happen, the homeowner will have to go back to the lender and ask for more money. This is not easy and may not be approved by your lender. If that is the case you will have to come up with the additional funds out of your pocket. If the homeowner doesn’t have the money they may be reduced to calling friends and family and borrowing from them. If you can’t get the funds the ultimate result could be the lender has to foreclose and sell the home, the uncompleted home (which few buyers will want), for the best price they can get.
A better solution is to request a fixed price contract with a Contingency Reserve. This is a dollar amount, over the cost to build provided by the builder, that can be used if there are sudden increases in the cost of materials, labor or fees. It is pretty standard to have a 5% or higher Contingency Reserve on fixed price contracts these days. For this to work the builder must agree that the total cost of construction would not exceed the cost to build plus the contingency reserve. If you never use the contingency reserve those funds do not roll over into your permanent financing. So the builder, while not guaranteed a profit, can pass along increases to a point and the borrower has a maximum cost they can plan for.
If you would like to know more, wish to discuss this or any other construction loan issues or apply for a Conventional, FHA or VA Construction Loan please feel free to call me at 586-917-5534 or email me at jerrythomas1958@gmail.com.
Comments(0)