While some general contractors like to get a substantial deposit before starting a project, construction lenders do not do business this way and nor should you. The first large payment should not released until all permits and approvals are in place, proof of insurance is provided, lien waivers are signed, and a substantial piece of work is completed, such as the foundation.
The contractor may want a down payment to pay for materials and rental equipment, and to pay his help and subcontractors such as excavation and foundation contractors. The contractor may argue that it is not his job to finance the project out of his pocket. On the other hand, most owners feel that it is not their job to finance the contractor’s business or to pay for work not yet completed or materials not yet delivered.
A reasonable payment schedule takes into account both these positions. You need to strike a balance where both parties share the costs and risks if the job runs into problems or is not completed for any reason. Neither party wants to be left “holding the bag”.
Some states, including California and Maryland, limit the size of the down payment on a home-improvement contract. Maryland allows up to one-third of the contract price, while California limits the down payment to 10% of the job cost or $1,000, whichever is less.
What’s fair? I don’t believe it’s reasonable to ask for a large down payment and to “front load” the budget, so the owner continually pays for work before it is completed. The contractor will not have to pay for materials until after his monthly bill comes in and subs know they will not get paid until the general contractor is paid.
Also, it is not the owner’s job to provide the contractor with working capital. If he does not have credit with suppliers or subs, and does not have enough cash to make payroll, that’s not a good sign.
It is the owner’s responsibility to pay promptly when agreed-to milestones are reached. The contractor should not have to wait to be paid for payment for work completed. Also there are situations where the owner needs to pay in advance. For example, if the job involves a large deposit on special-order materials, it is reasonable for the owner to make a significant contribution towards that deposit.
In order to the the costs and risks of the job shared equally, instead of a large down payment, try negotiating one of these options:
More frequent payments: Instead of five large payments, make ten smaller payments, but still tie them to work completed and materials delivered to the site.
On special-orders: You make the deposit yourself and purchase the materials. If things blow up, at least you will own the expensive windows, SIPs, or custom millwork when it arrives.
Agree to a reasonable down payment, but reduce the first one or two progress payments to avoid getting too far ahead on your payments.
Read more on Construction Loans and Draw Schedules
Should Contractor Use Down Payment to Pay Costs?
I am an owner. I have a Lump Sum Contract with a Licensed contractor to build a house for $300,000 I paid the contractor a down payment of $50,000
Owner purchased all materials, and paid all contractor and subcontractor labor cost on time. There have been no change orders. The build is 4 months past the completion date. Delays were do to contractor not showing up to work for weeks at a time.
The total cost for material and labor is currently at $300,000 I have estimated the labor cost to complete the build at $30,000 and a time frame of two weeks to complete. The contractor says he is underwater on the job and can not finish the build. He has not quit or claimed a breach of contract.
Question 1: Is the down payment part of the contract material and labor cost?
Question 2: Is the contractor required to use the down payment for completing the build?
I’m not sure I fully understand your contract terms for payment.
In most fixed-price contracts, the contractor pays for all materials, labor, and subcontractors out of the contract price and, if he bid the job correctly, has enough money to cover all hard and soft costs, including overhead and profit.
Any down payment made to the contractor is a portion of the fixed contract price. So the answer to questions 1 and 2 is, yes, the down down payment is part of the fixed bid and should be used to complete the build – unless you have contractually agreed otherwise.
It sounds like may you have a different arrangement, where you paid for materials and subcontractors directly. Is that the case? Did you hire the contractor for labor only? Also, is the $50,000 down payment in addition to the $300,000 you have paid out? Did you pay all this money to the GC or to suppliers and subcontractors as well?
On a typical a fixed-bid contract, the contractor assumes most of the risk of cost overruns, for which there are many possible causes. Unless you are responsible for the cost overruns due to changes you requested, or added costs are caused by hidden or changed conditions, or other contract terms (like changes in material prices), then legally the contractor is required to finish the job.
That doesn’t mean the contractor cannot try to renegotiate the price. If that’s the case, and if you think that his concerns are valid, you may agree to some or all of the additional costs.
If the contractor simply refuses to finish the work and walks away from an incomplete job, then it may be time to speak with a lawyer. If you have paid out the full contract amount for job for a job that is $30,000 shy of completion, then you have lost your main leverage in negotiations – that is, money withheld until satisfactory completion. It sounds like you may have made final payment for an incomplete job.
Your choices to resolve the dispute are direct negotiation with the contractor, mediation, arbitration (if the contract has an arbitration clause), or a lawsuit. Sometimes a demand letter from a lawyer is enough to persuade a contractor to fulfill his contract obligations since the costs of a lawsuit in time and money are very high for both parties.
No easy answers here, but direct negotiation, with some type of compromise, is usually the cheapest and fastest approach to settling this type of dispute. If both parties are equally unhappy with the outcome, that may be the best you can achieve…and then move on with your life.
This must be written by a homeowner, not someone who runs a business.
I was a contractor for many years, but now I am a homeowner who hires contractors from time to time. The information provided is intended to be fair to both the contractor and homeowner. On the home page it states that “Our mission is to help homeowners plan and complete successful building and remodeling projects, from start to finish.” So we want to make sure the owner gets fair shake, but believe that a project is a success only when both parties feel good about the outcome.
Very evidently. Asking the contractor to go purchase materials on his own credit is ridiculous. Never mind the hours and hours of work that go into design, renderings, zoning and building departments long before the project starts. Having the down payment be enough to cover materials, or the first set of materials, is something that I and every builder I know does. This article is just plain mistaken. It’s unfortunate because people will take it as gospel.
Have to call BS on this comment. Clearly a contractor who tries to get half or more of the money up front (nice to have beer money before the job starts). It is EVERY LEGITIMATE BUSINESS’S responsibility to pay their expenses prior to billing the customer for work performed.
That said, there are reasonable ways to mitigate cost & risk for both parties. E.g. 10% down (earnest money), 30% at Milestone A, 60% upon completion.
Tony Fry says
Our company always requires 75% as a down payment. We have been in business for over 25 years.
YES I WILL. I am am not ending up in court trying to get my money back when you mess up or don’t finish. I won’t be anybody’s fool. THIS IS GREAT ADVISE PAY HEED ALL.
Can I Avoid Down Payment on Construction Loan?
If you can get your home built for the 75% or 80% of what the bank is lending you, will you still have to pay the bank any money out-of-pocket for a down payment?
There are many varieties of construction loans, but in general, the bank requires a cash down payment so you have some “skin in the game.” The deposit can range anywhere from 10% to 30% of the total appraised value of the completed home plus land. If you own the lot outright, the land can count toward some or all of the down payment.
Banks do not want to own a half-built home if you or the builder defaults, so they approach construction loans very cautiously. They make sure that you spend your deposit money first. For that reason, your down payment will be due at the loan closing and will be disbursed to the builder in the first one or two draws.
Once your own money is spent, you’ll be using bank’s money and be charged interest. Most of these loans are interest-only until the home is complete. You pay interest only on the amount that has been disbursed, much like a credit card with a very high limit. You either pay off the full loan amount when the house is completed or roll it into a conventional mortgage – called a one-time-close loan.
Most construction loans require a detailed house design, a realistic budget, an approved builder with a proven track record, and a draw schedule based on a “schedule of values” for each phase of construction. With the required documentation, I’m not sure how you plan to get the house built for 20% less than the amount of the construction loan.
In most cases, custom homes end up costing more than expected, not less, which is why lenders add a 5% to 10% contingency reserve to the builder’s estimate in calculating the loan amount.
Read more about Construction Loans
What Is Reasonable Deposit on Custom Home?
We are under contract for a lot and will be obtaining a lot loan with 20% down. We have also identified a builder we would like to use after interviewing 3. This builders contract requires us to give him 10% down in cash as “good faith” or having “skin in the game” in case we were to walk after he has invested money in the project and before taking his first draw on our construction loan. Our estimated construction costs right now are $1.6mm so we would be writing builder a check for $160,000 at time of contract. This is after giving him an initial check for a retainer in the amount of $40,000 for soils testing, surveys, “logistics,” architectural design (using his architect) and home structural engineering. He indicated he does not make a draw on the construction loan until 70-90 days after contract during which time he has spent funds on back office work, pulling permits, doing energy rating studies, drainage plans, surveying, staking, excavating, grading the lot, pulling water and sewer from the taps, underground plumbing and doing the structural floor. He said it’s when he’s ready to frame that he makes the first draw with the construction lender. Our $ 160,000 “deposit” with him is then credited at the final draw. He said this is protection for him in case there is trouble, or something happens to us and we decide to walk from the deal. He also sold it as being in our best interest as we wouldn’t be paying interest on the construction loan by him not making a draw for these expenses the first 70 to 90 days and he would be underwater if we didn’t give him the deposit prior to his first draw. The bank we would like to use for our construction/perm. Loan is US Bank which does not allow this. One bank that would allow us to do this is Vectra but their perm. Loan package is not as attractive (only offer 10/1 arm vs. US Bank 30 year fixed on perm.). We have suggested an escrow with US Bank for the 10% deposit which US Bank is willing to do but the builder is not. The builder is a large, well respected, custom and semi-custom builder in our area. Thoughts, ideas, concerns? Is this typically a requirement of builders?
There’s a lot to unpack in your question. Deposits on custom homes can vary a great deal depending on circumstances and local market trends, but usually range from 5% and 10% in my experience — with lower percentages on larger projects. How the deposit is treated, however, can vary a lot and this arrangement seems very one-sided.
This sounds like a design-build project where you are paying the contractor for both design and construction. These are complicated contracts with a lot of moving parts. What if you don’t like the design or the design they provide costs a lot more than planned? What if you like the design, but decide you want to use another contractor? Do you own the design after paying such a large deposit? (The answer should be yes.)
Each party is taking on risk in going into this sort of project. You are taking the risk that the builder will not complete the project for some reason (for example, they will declare bankruptcy) or that the costs of the project will spiral out of control. It’s unclear from your email whether you are getting a fixed bid before construction begins or this will be a cost-plus project – something you should avoid on a project of this scale.
The builder is at risk that you will walk away from the project after he has spent a lot of time and money on preliminary work: design, estimating, engineering, and permitting, for example. There is also a risk that the costs will rise due to site conditions or owner changes and you will not be able to afford the project. Since the contractor does not own the lot, he cannot find another buyer, but must walk away with whatever money he has received.
In general, you don’t want to pay for work not yet completed and materials not yet delivered. That is the basis of the draw schedule – as work is completed it is paid for. This keeps the contractor motivated to get work completed in a timely manner. On the other hand, the contractor does not want to pay out a lot of money that he has not yet collected. So the payment schedule should balance these two needs.
In my opinion, the $40,000 retainer (just another name for a deposit) is reasonable for the design and other preliminary work. As the owner, I would make sure that I would own the plans and engineering work if, for any reason, the contractor does not end up doing the construction. Design-build contracts should clearly separate the design and construction phases of the project so you have an out if the design is unsatisfactory, the final cost too high, or you decide to part ways based on problems during this phase of the project.
The $160,000 deposit credited to the final draw means that the contractor is always $160,000 ahead of you. If he should default for any reason, you will be out a lot of money. In essence, you will be lending the contractor $160,000 for the duration of the project at 0% interest. Putting the money in escrow seems like a good option as it shows the builder your good faith and financial strength, but protects you if the builder defaults or does not meet his contractual obligations. I would suggest asking the first bank why they would allow this approach – I’m sure they have their reasons.
All custom build contracts involve a lot of trust on the part of both parties. Design-build contracts require greater trust, especially if combined with cost-plus or negotiated (non-competitive) bids. But the trust has to go both ways.
If you are willing to put up $200,000 as a non-refundable deposit, I would expect that it is credited to the first draw, not the last. That way the builder is compensated for his early soft and hard costs and assured that you have “skin in the game.” You are protected from having the builder default at some point and walk away with your $160,000.
Of course, if your bank won’t go along with this, then the question is moot. Find another bank or find another contractor who is more reasonable. In any event, I would definitely have this contract reviewed by a construction attorney – there is a lot of money at stake and a lot of risk inherent in this type of project.
Best of luck with your project!
Related links: Draw Schedules Design-Build Bids Construction Loans Choosing a Contractor Cost-Plus Contracts
Thank you for your response. I greatly appreciate you taking the time to provide this information and guidance. The builder’s 10% deposit requirement and conditions on it benefit no one but him and the more I think about it the more I realize that it is risky and unreasonable for us to agree to his terms. His terms are so inequitable and outlandish I felt that I was missing something in the equation or didn’t have a complete and accurate understanding of this from a builders perspective. I haven’t even run it by our real estate attorney as I know what he would say and I would be paying him for the same advice that you and a few others have given me on the matter. The golden rule in construction and any home improvement agreement or contract is to never pay for work before it is completed or materials that haven’t been delivered. The same holds true for a $500 interior paint job or a $2 million custom home.
Again, thank you for your email and advice. I love your Building Advisor website and have found it to be extremely helpful in this process.
Jason Jones says
Questions on Down Payments and Owner-Supplied Work
We are building a new home on a cost-plus-20% contract. The estimated price for our house was $300,000. As part of the contract, we were required to pay a down payment of one half the contractor’s percentage based on the estimated price. So we wrote a check for $30K to get started. We are just over halfway complete, and the contractor has billed us for enough to justify the percentage we prepaid him and can now start billing us for 20% on every invoice.
Here’s the thing: We have done some of the work ourselves, and paid for several high ticket items in an effort to lower the overall cost of this project. Our contractor said early on that he would not bill us for material or work he did not pay for or manage. He gave us a bill for the other half of his percentage stating that he was due his full percentage of the projects estimated cost!!! To make matters worse, he wants the full amount up front! I NEVER pay in full for incomplete work. We have paid for about $50K of materials and labor ourselves. Can he charge us 20% on work and material he did not pay for or manage in any way? And he gets his 20% on every invoice, not up front, right? Thanks so much.
The short answer is that the payment schedule, and how you would account for owner-supplied labor and materials, should have been defined up front in writing, as part of the contract.
If there is no written contract, or the contract is unclear regarding the payment schedule and markup of owner-supplied work, then it becomes an issue for negotiation. It sounds like you had some verbal agreement about not being billed for work or materials you provided, but your agreement may not have covered his right to charge a markup on those materials. And while verbal agreement may be binding in theory, in practice establishing exactly what was agreed to is never easy.
Since I don’t know exactly what you and your contractor agreed to (and I am not a lawyer), I can’t offer you specific advice. However, I agree in general that you should not pay for work not yet completed and, therefore, should not fork over another $30,000 “down payment” for the second half of the job. You already paid a large down payment at the beginning of the job. You always want to keep enough money on your side of the table to pay any work that is not completed properly by the contractor.
On the issue of work and materials supplied by you, the owner, there is really no standard contract procedure. Some contractors welcome this and others avoid it at all costs and claim that it makes their work harder. The key is to agree beforehand exactly what work you are going to do and how it will affect the cost and payment schedule for the rest of the job.
If the contractor agreed early on that you would not be billed for work or materials that you provided, then he should adhere to that. He should also not charge you 20% markup on work and materials you provided unless you specifically agreed to those terms in writing.
Some contractors will claim that they need to charge the same markup on your portion of the work, since they still had to manage that portion of the work and are responsible for any problems with the completed house. In that sense, it may be reasonable for them to charge a a reduced management fee on your work. Ideally, this would have been figured out and agreed to in writing ahead of time. If not, then the burden of proof is on the contractor to explain why you should pay a 20% markup on materials you purchased and installed. If necessary, sign a document stating that you will take full responsibility for any future problems related to these portions of the job.
Best of luck in working out a mutually agreeable solution to these issues and getting the job completed on time and on budget.
Contractor Spent Deposit on Materials Rejected by HOA
Hi. I paid a contractor a $7,000 deposit, which he used it to buy wood for my patio cover before getting HOA approval. The HOA won’t approve wood, only Alumawood.
My old patio cover was wood. I have lost $7k dollars. Is contractor responsible at all?
Sorry to say that the contractor is probably not responsible for the cost of these materials. This is a legal question and I am not a lawyer, but can provide general information.
Unless you had it written into your contract that the contractor was responsible for getting HOA approval, or would not purchase materials until HOA approval was secured, it is unlikely that the contractor would be held legally responsible. Sounds like he was acting in good faith on information you provided and could not be expected to know the details of your HOA regulations.
At this point, I would suggest discussing with the contractor whether any or all of the materials are returnable. Most lumberyards will take back unused materials in good condition. There may be a restocking fee or contractor charge for the time he spent purchasing, handling, and returning the materials.
If they are not returnable for some reason, perhaps the contractor would be willing to buy the materials from you for future projects. Worst case, you can try to sell the materials yourself through Craigslist or a local classified ad.
You might also try appealing the HOA decision, especially if it seems arbitrary, inconsistent with other rulings, or in conflict with written HOA rules and regulations. However, design review of exterior finishes and modifications is well within the legal authority of HOAs so the association has the final say.
Best of luck in finding a good resolution!