Fixed cost and cost-plus contracts are two common types of contracts used in home construction. They differ in how they determine the price and payment structure for a project. Here’s an explanation of each:

Fixed Cost Contract:

Definition: In a fixed cost contract, also known as a lump-sum contract or a fixed-price contract, the contractor agrees to complete a specific scope of work for a predetermined, fixed price. This price is typically set before the project begins and does not change unless there are mutually agreed-upon changes to the scope of work (change orders).

Characteristics:

Predictable Costs: The client knows the exact cost of the project upfront, which can help with budgeting and financial planning.
Risk Transfer: The contractor bears the risk of cost overruns, unexpected issues, and delays. They must complete the project within the agreed-upon budget. Change Orders: Any changes to the project’s scope or specifications typically result in change orders with adjusted prices.

Advantages:

Budget Certainty: Clients have a clear understanding of the project’s total cost as long as the specifications included in the contract is clear and concise. Risk Management: Contractors are motivated to control costs and complete the project efficiently to protect their profit margins.

Disadvantages:

Limited Flexibility: Changes to the project can be costly and time-consuming. The builder is in an advantageous position to set whatever price they want and often use change orders to recover losses or cost overruns in other areas.

There may also have been aspects of the construction that were assumed to be included and subject to costly change orders leaving the homeowner feeling bound to the contract and not getting the house they dreamed of. Potentially Higher Initial and final Cost: Contractors will include contingencies in their bids to account for unforeseen issues. Most contractors will add 33% or more to the estimated cost of construction for profit and contingencies.

Quality of Construction: The quality of the home can sometimes be lower. A fixed cost contract might encourage some builders to cut corners on construction to increase profit. Especially if they have quoted too low and are at risk of losing money on the project.

Cost-Plus Contract:

Definition: In a cost-plus contract, the client agrees to reimburse the contractor for the actual costs incurred during the project, plus an additional amount (usually a fixed fee or percentage of costs) as profit. This type of contract is often used when the project’s scope is uncertain or the homeowner would like the flexibility to make and change their choices and to be more involvement in the construction process.

Characteristic:

Transparency: The client has visibility into the actual costs, including materials, labor, and overhead expenses. Builders using this contract should be providing the homeowner with all receipts for materials, subtrades and the timesheets for the builders’ employees to be reviewed by the homeowner.

Flexibility: Changes to the project scope are typically easier to accommodate without contract modifications or added costs.

Advantages:

Adaptability: Well-suited for projects with evolving requirements or uncertain conditions. Ideal for custom homes and those who want flexibility.
Collaboration: Clients and their builder work together to manage costs and make informed decisions to meeting the clients needs.

Disadvantages:

There is a level of trust the homeowner must have in the builders original estimate. That it is accurate and that they have a priority to work efficiently and to stay on budget.

Conclusion:

There are advantages and disadvantages to both types of contracts. It is the utmost importance to choose a reputable builder who cares about their work and the satisfaction of their clients.