A guide to common contract structures – how they work, who carries the risk, and what to consider before choosing one
Introduction
Once you’ve selected a contractor, one of the first things you’ll review is the construction agreement. The way that the agreement is structured affects pricing, flexibility, risk, and how changes are handled. Understanding the different types of contracts used in construction will help you feel more confident before you sign.
This page walks through the most common contract types used in residential construction and tenant improvement work, along with tips for how to navigate conversations with your contractor about which one is right for your project.
Common Types of Construction Contracts
Fixed Price (Lump Sum) – Most Common
The contractor agrees to complete the defined scope of work for a set amount.
Best for:
- Projects with a clear, well-defined scope
- Owners who want cost certainty
Key Points:
- Scope must be fully documented up front
- Any changes require written change orders
- Simple billing, but can create friction if the scope wasn’t clear at the start
Cost-Plus (With or Without Guaranteed Maximum Price)
You pay the contractor for actual labor and material costs, plus a markup for overhead and profit. Some contracts include a Guaranteed Maximum Price (GMP) to cap the total spend.
Best for:
- Custom homes or evolving designs
- Owners who want visibility and flexibility
Key Points:
- Offers transparency into actual costs
- GMP adds cost control, but only if it’s clearly defined
- Requires detailed tracking and good communication
Time and Materials (T&M)
The contractor charges hourly labor rates and the actual cost of materials. There’s no fixed project price.
Best for:
Key Points:
- Can be fast and flexible
- Requires careful monitoring of hours and materials
- Consider setting a “not-to-exceed” limit to avoid runaway costs
Unit Price
Work is priced per unit (e.g., per linear foot, per square yard). More common in civil work, trenching, demolition, and utility installs.
Best for:
- Work that can be clearly measured but is hard to quantify upfront
- Phased site work or grading
Key Points:
- Useful when quantities vary
- Requires a clear definition of how units are measured and tracked
How to Choose the Right Contract Type
There’s no single right answer—it depends on your comfort level, how developed your design is, and how much change you expect along the way.
When reviewing contract options, consider:
- How well-defined is your scope? Is the design complete, and do you know what’s included?
- Do you want cost certainty or flexibility? Fixed-price contracts lock in the cost, while cost-plus offers more adaptability.
- Are you comfortable managing change? Cost-plus and T&M require more involvement in reviewing invoices, allowances, or scope shifts.
- Are you working with a lender? Some lenders prefer fixed-price or GMP contracts for funding.
In most cases, the contractor will propose the structure they are most familiar with or feel most comfortable using. If you’re working with a contractor who primarily offers one contract type, it’s still worth having a conversation about whether that structure works for you.
At this stage, it’s important to speak up.
Ask the contractor to walk you through their typical agreement and why they use that format. Don’t be afraid to request adjustments or clarify how certain elements will be handled (like change orders, unknown conditions, or shared responsibilities).
This conversation helps ensure that:
- You understand how you’ll be billed
- You’re comfortable with the flexibility (or limits) of the structure
- There are no assumptions about what’s included or excluded
The goal is to land on a contract type that aligns with the nature of your project and one that both parties feel comfortable working within.
If You’re Using Financing: Check for Lender Requirements
If you plan to finance your construction project through a lender, whether it’s a construction loan, renovation refinance, or home equity product, it’s important to confirm if they have any specific requirements for your construction contract.
Some lenders require:
- A fixed-price (lump sum) contract before approving or releasing funds
- A clearly stated draw schedule tied to construction milestones
- The use of a licensed general contractor, even for smaller projects
- Specific contract templates or disclosures, especially for renovation loans like FHA 203(k) or Fannie Mae HomeStyle
In some cases, lenders will not accept time-and-materials or open-ended cost-plus contracts, especially if the scope is not fully defined. If your project involves financing, it’s a good idea to:
- Ask your loan officer or lender representative if they have contract format preferences or requirements
- Request a sample draw schedule or contract checklist if available
- Share this info with your contractor early, so the agreement can be tailored to meet those terms
Addressing these details upfront prevents delays during funding and ensures your contractor’s contract will be accepted without extra paperwork or rewrites.
Common Construction Contract Formats
Even with the same pricing model, contracts can look very different depending on who created them. These are the most common formats you’ll see in residential and light commercial construction:
AIA (American Institute of Architects) Contracts
- Professionally written, widely used in the industry
- Define clear roles for owner, contractor, and architect
- Can be lengthy and technical, but offer strong structure and fairness
State- or Locally-Mandated Agreements
- Some states (like California) require specific contract disclosures
- Often used in home improvement contracts
- Provide basic protections, but may not cover complex scope or change procedures
Contractor-Written Agreements
- Many contractors use their own templates
- Some are thorough and professional, while others may be missing key details
- Important to review carefully, ask questions and don’t assume anything is “standard”
Design-Build Contracts
- Used when one firm handles both design and construction
- May include flexible allowances and shared responsibilities
- Best reviewed carefully to clarify included scope, change processes, and design ownership
What’s Next: Reviewing the Contract Before You Sign
Once you’ve agreed on a contract type and format, it’s time to review the actual agreement. On the next page, we’ll go over what to look for in the fine print, what’s commonly included, what to clarify, and what red flags to watch out for.
Continue to Contract Review Guide to learn how to review a construction contract.