When embarking on a construction project, one of the key decisions you’ll face is the type of building contract you choose. This decision not only impacts your building journey but also how lenders assess your loan application and the risks involved for you as a borrower. At Residential Lending Group (RLG), we understand these nuances and are here to help you navigate them.
What Are Fixed Price and Cost Plus Building Contracts?
Fixed Price Building Contract
A fixed price contract sets a total, agreed-upon price for the entire construction project before building begins. This contract outlines the scope of work and the exact cost, providing you with financial certainty and a clear budget.
Cost Plus Building Contract
In contrast, a cost plus contract means you pay for the actual costs of construction plus an additional fee (which could be a percentage or hourly rate) to the builder. This means the total price can vary depending on the actual expenses incurred during the build, such as materials and labour.
How Do Lenders View These Contracts?
Risk Assessment for Fixed Price Contracts
Lenders generally prefer fixed price contracts because they offer more predictability. Since the total cost is set upfront, lenders can more confidently assess the loan amount required and the security value of the property once completed. This helps reduce the risk of cost overruns affecting your ability to repay the loan or complete the project.
Risk Assessment for Cost Plus Contracts
Cost plus contracts are viewed as higher risk by lenders. Because the final cost can increase significantly due to unforeseen expenses, lenders require borrowers to demonstrate access to additional funds to cover potential cost increases. This can result in a lower maximum loan-to-value ratio (LVR) or stricter servicing requirements to mitigate the risk of the loan exceeding the value of the property upon completion.
Risks to You as the Borrower
Fixed Price Contract Risks
- Less flexibility: Changes or upgrades during construction may be costly or require contract variations.
- Potential for disputes: If the scope isn’t clearly defined, disagreements can arise over what is included in the fixed price.
Cost Plus Contract Risks
- Cost uncertainty: Total construction costs may exceed your initial budget, leading to financial strain.
- Loan approval challenges: Lenders may limit your borrowing capacity, requiring you to have significant additional savings or equity to cover cost increases.
- Project delays: Variations and ongoing cost adjustments can delay completion, impacting your living arrangements and finances.
How RLG Can Help You Navigate These Options
Choosing the right building contract and understanding how it affects your borrowing capacity is crucial for a smooth construction journey. At Residential Lending Group, our team works closely with you to assess your financial situation, explain lender requirements, and help you select the most suitable loan structure for your build.
We’ll guide you through:
- Understanding lender policies related to different contract types
- Assessing your borrowing power and risk exposure
- Preparing your loan application with clear documentation to improve approval chances
What About Loan-to-Value Ratios (LVRs)?
Lenders typically apply different LVR limits depending on the contract type. For fixed price contracts, you might be eligible for a higher LVR (often up to 80%), meaning you can borrow up to 80% of the combined value of your land plus the fixed contract price. This can maximise your borrowing capacity.
For cost plus contracts, lenders may reduce the maximum LVR to around 70% or less, reflecting the higher risk. This means you might need a larger deposit or equity buffer to secure the loan, reducing how much you can borrow relative to the total project cost.
Disclaimer: This blog is for informational purposes only and does not constitute financial advice. Lending criteria, terms, and conditions apply. Eligibility and loan terms vary between lenders. You should seek personalised advice from a qualified mortgage broker or financial adviser before making any borrowing decisions.