How to manage budget changes during home construction


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Ask a Lender
April 6, 2017 | Updated September 18, 2017


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Key Points

Home-construction budgeting tips

  • Plan Ahead. Try to account for all soft and hard costs in your estimate.
  • Prepare for changes. Add a contingency reserve to your loan to cover overruns.
  • Secure more money. Change orders can sometimes be used to get extra funding.
  • Don't worry. Many home-construction projects go over budget.

Most contractors will tell you that construction projects routinely go over budget. This isn't necessarily poor planning on your part or the part of the contractor — although poor planning will almost always result in budget overruns. This is just the nature of construction.

Sometimes, materials cost more than you estimated. Permit delays can put you behind schedule so labor costs rise due to overtime. Maybe you just decided to upgrade to marble countertops.

Contingency reserve

Any number of things can happen in the 12 months it takes to build a house, and lenders know that, which is why construction lenders offer a contingency reserve. This reserve is an additional 5 to 10 percent of the hard costs of construction — which are the materials and labor costs included in your original estimate. The reserve can be used to pay for unforeseen cost overruns during construction.

Contingency reserves are not automatically added to construction loans when you are working with a contractor, but may be required if you plan to build the house yourself. If you are doing the work yourself, make sure your original estimate covers all of the costs of construction, not just land, materials and labor. You also will need to pay a number of soft costs throughout construction, including permit, survey and utility-connection fees; land and school taxes; and architectural and engineering costs for blueprints and plans. The more you plan upfront, the less chance you will run into problems while building.

Even when using a contractor, adding a contingency reserve to your construction loan is a good idea, because without one, you will have to cover any overages out of your own funds, find alternative financing to make up the difference, or possibly pay a fee to put in a change order to get additional funding from your construction lender. All of these funding sources likely will cost you more than the cost of the contingency reserve.

One-step vs. two-step loans

Change orders are easier with a two-step construction loan than a one-step (construction-to-permanent) loan, because one-step loans often lock in a fixed loan amount, which then converts to a standard mortgage once construction is complete. With a two-step loan, you get a separate mortgage to pay off the construction loan once you take occupancy of the home, so you are not locked in until you secure the long-term loan, which must cover your entire construction loan, including overruns. If you can't get approved for that higher amount, you will have to find a way to pay off the difference, however.

In the rare case that you come in under budget on your home-construction project, any funds left in your construction-loan account, including anything left in the contingency reserve, will go to pay down the principal on your long-term mortgage, whether you have a one-step or two-step construction loan.


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