Several of my posts have echoed the theme of keeping a contingency fund to protect yourself against unbudgeted expenses. But it is so important that I’m going to elaborate.
The Unforeseeable and Cost Overruns
No matter how vigilant you are, building a new home always produces a few surprises. Unfortunately, these surprises often result in additional expenses. When they appear you might be tempted to blame someone, but it is not possible for everyone to foresee everything. For example, after the general contractor (GC) begins excavating for the foundation, he might discover that your property contains an underground spring exactly where you want to put your home. To prevent a wet basement, you will need to take some costly and unbudgeted precautions. Unless you had the GC dig a test hole in this area before he finalized his contract with you, neither of you could be expected to have anticipated the problem.
Mistakes and Cost Overruns
There are other sources of cost overruns than the unforeseeable. Failing to read your building specifications closely is a common source. It can cause your home to be built to specifications you do not want and to be missing features you expected to receive. Correcting either type of mistake will add to your expenses. Your contract may include allowances for some preconstruction tasks that are insufficient to cover the actual costs when they are later determined. This could include, for example, completing a property survey or paying for the utility hookup or building permit. If you discover you need to complete these tasks after closing on the construction loan, the dealer and GC will need to stop what they are doing until you come up with the money to complete the tasks.
Other Sources of Cost Overruns
You may be forced to absorb additional costs if you change your mind and, for example, decide you want hardwood flooring instead of carpet. In other cases, a town official could be responsible for your additional costs. For example, the building inspector may require your GC to complete some costly additional work that is not included in his contract because it is not mandated by the building code. You may also incur additional financing costs should the project be delayed by inclement weather, material shortages, or subcontractor scheduling conflicts. Your GC may or may not charge you for these problems, but your lender will almost certainly require you to pay additional interest if you are financing your home with a construction loan.
Plan for Surprises by Creating a Contingency Fund
The complexity of building a home presents so many opportunities for mistakes that it is best to simply plan for them. Although you cannot budget specifically for what you cannot foresee, you can create a contingency fund to protect yourself against unbudgeted expenses. For a modular home, 3 percent of your modular and GC expenses will probably suffice. You can keep a reserve of cash for the contingency fund or ask your lender to include a contingency fund as a budgeted line item in the construction costs. Some lenders will do this even if you do not ask, and even if you do not want them to; many lenders only require this for stick-built homes, since they are historically more prone to sizable cost overruns.
How to Create a Contingency Fund
If your total construction costs already bring you to the maximum amount the lender will give you plus your down payment, the only way you will be able to create the contingency fund is to eliminate other expenses. The best way to handle this situation is to eliminate something you can readily add later. If you get lucky and avoid drawing from the contingency fund during the project, you can spend the money on the eliminated item. If you are forced to tap into the contingency fund, you will spend money you undoubtedly hoped to save, but you will not be forced to come up with money you do not have.