How Do Builders Price New Homes?
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Did you know that there are two types of contracts that builders use to price new homes? Those two types of contracts are called “fixed price” and “cost-plus.” If you’ve never build a home before, you’re probably wondering which type of contract is better. We’ll show you the ins and outs of both contracts so that you can make the right choice when you build your new home.
The Fixed Price Method
If your builder uses the fixed price method, he will factor for all of the costs associated with building your home – which includes all materials and labor as well as the builder’s overhead or profit – and then he’ll present you with the total cost for the project. The price on your contract is the amount you’ll pay once the home is complete.
Advantages
- The biggest advantage to a fixed price contract is that it insulates you from cost overruns. If your project goes over budget in some unforeseen way, the builder must absorb that cost.
Disadvantages
While the builder absorbs cost overruns, the same is true in reverse. If your project comes in under the budget, the builder gets to keep any remaining money as profit.
With this type of contract, the only number you’ll see is the final price – not the cost of the materials, the labor, the builder’s overhead or anything else.
More unscrupulous builders may try to cut corners in some areas if other parts of the project are starting to soak up their profits.
The Cost-Plus Method
The cost-plus pricing method is a bit more complex, but many builders and buyers prefer it to the fixed price method. With this method, your contract will list the builder’s costs and his profit. Unlike fixed price contracts, the final price of a home built under a cost-plus contract can increase or decrease depending on the actual costs of materials and labor.
Advantages
The biggest perk to the cost-plus method is its transparency. Because you can see what the builder is charging for both costs and profit, you can more easily determine if the builder is charging too much.
If your project comes in under the budget, you’ll pay less once the home is complete.
Because the builder’s fee isn’t threatened if the project goes over the budget, he is less likely to sacrifice quality to preserve his profits.
Disadvantages
If the cost of your home building project increases (or if a builder estimates poorly), you’ll be stuck with a larger bill than you anticipated.
A poorly worded cost-plus contract may leave room for disputes. For instance, if you feel that a subcontractor did shoddy work, do you pay the repair and replacement costs or does the builder?
Which type of contract is better? The answer to that question depends on both you and your builder. Some buyers are more comfortable with fixed price contracts while others trust that their builders will come in well under the projected budget. In other cases, the builder that you want to work with may only offer one type of contract. In the end, the right choice is the type of contract that you feel most comfortable signing.