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8 Expert Tips to Help You Manage Financial Risk When You Remodel

10/11/2013 01:58 pm 13:58:41 | Updated Jan 23, 2014

Remodeling can be a confusing and stressful process, with most of the stress centering around the amount of money involved and the complex nature of construction projects. Knowing and following these tips to manage the finances of your home remodel can save you from major headaches -- or disasters -- down the line. Here are Bolster's guidelines to help your project finances through the process.

1. At the beginning, work to reduce the chance that something goes wrong because mistakes can cost money. The key to financial risk reduction is specificity -- be clear and granular with what you want. If you define the desired outcome, you'll know whether you're getting it or not. This means creating a very detailed scope of work, reviewing it carefully with your contractor, and managing the project based on completion of every element your plan describes.

2. Reduce your financial risk by having a fixed price contract. The nature of remodeling is that there are many, many factors outside the control of both you and your contractor. As such, the only way to be financially responsible is to ensure your contractor is financially aligned to deliver your project at a set price. Make sure you sign a fixed price, lump sum contract (as opposed to ones known as "cost plus" or "time and material" contracts, since these often lead to lawsuits and problems for everyone involved). Keep in mind, you need this alignment not because you expect something bad to happen, but rather because your contractor is in a better position to handle the risks if something does go wrong.

Note: This does not mean "squeeze your contractor and pay as little as possible for your project" -- that can affect the chances the project is delivered at all. Rather, it means, "own your scope of work from the outset, partner with the contractor, and agree exactly on how it will be delivered according to budget, quality, and schedule."

3. Create a smart payment plan. Your payment plan should make sense for your project, and include a schedule so your contractor only gets paid for work completed to your satisfaction. Rule of thumb: Give your contractor the funds he needs to pay for the materials -- the long-lead items -- and give the benefit of the doubt that they will use your money wisely. If the materials make up the bulk of the cost of the project, you should expect to pay a higher down payment. Ignore hard and fast rules like, "Never put down more than 10 percent" -- how can you expect to only put down 10 percemt if the materials alone cost more than that? (Granted, you could buy the materials yourself, and eliminate the risk that your contractor will run off with your money -- but then you'll lose the benefit of having your contractor manage and coordinate the project.)

4. Have a task schedule, and only pay for tasks completed on that schedule. In your contract, you should specify to the best of your ability the exact tasks that need to be done and how much each task costs (specificity, granularity, whatever you call it, is essential) and then check and see if the work is done. Only pay the allotted fee for tasks if they're completed -- if your contractor says, "I need you to pay the $10,000 you promised me for lighting installation, even though I haven't finished it yet," politely decline. Pay by task, not by milestone -- think about your project as, "$10,000 for cabinets, $5,000 for plumbing, $3,000 for tiles and $2,000 for a sink," rather than, "$20,000 for a kitchen."

5. Know whether and why you need a change order. Often change orders accompany an argument over whether or not a piece of the project falls inside the scope of work -- this is by far the most common cause of arguments between homeowners and contractors, since more often than not they mean more money changing hands. Having a very clear scope of work will be your best leverage against unnecessarily expensive change orders.

6. Only make the final payment on the project once your task list is complete. Every task on the list should be finished before you hand over the last check. You may have heard, "withhold a small amount of the total cost (say, 5 percent) at completion, just in case you discover problems after the contractor has packed up and left." The chances are slim that this 5 percent will be enough incentive to get your contractor back to fix problems once the job is done -- and the 5 percent may already be included in the budget she provided you so there is no incentive to return. Remember: a good contractor will return to fix problems with his/her workmanship on reputation.

7. Motivate your contractor by proving that he/she will get paid. Think about it -- if you know your employer may not come up with the money for your next paycheck, do you have any motivation to work? The best way to ensure great work from your contractor is to prove that you can and will pay him. Consider handing over a bank statement or other proof of available funds at the beginning. Your contractor will know the money is ready and waiting to be disbursed, so he'll be motivated to do a good job and focus on your project.

8. Never pay in cash, and keep receipts -- having no proof that you actually paid puts your home at risk. If you hand over cash, you have no paper trail for the payment you made, and you have no protection if you then discover that something is wrong with the work.

Note: Some contractors convince homeowners to pay cash with the promise that they won't have to pay sales tax. Remember, there is no sales tax on a "capital home improvement." What paying cash really means is no paperwork, and therefore no accountability or recourse if the contractor fails. Plus if you don't have records, you risk having subcontractors place mechanics liens against your home -- meaning that you'll have a serious problem when you go to sell.