4 Rules for Contractor Payment Schedules
A contract for a home addition or remodel has several components. For many homeowners, this may be the first and only large project they do on their home, so their experience with general contractors and home improvement contracts may be limited.
The American Institute of Architects (AIA) provides standard contracts for small projects which can be customized to each project. The AIA contract is an ideal tool as it is fairly exhaustive and has been developed and updated for years by architects, lawyers and general contractors having stood the test of time and thousands of prior projects. For many, however, the contract is quite large, cumbersome, and filled with unknown jargon. As a result, many contractors and homeowners engage in projects (particularly smaller projects) based on contractor-provided contracts.
In this writing, I will discuss the Payment Schedule, which is an agreed upon schedule by which the client (homeowner) will be paying the contractor for the work provided. We have seen many versions of payment schedules proposed by contractors, and I generally advise revisions to these based on the following four rules:
1) Tie payments with work completed.
The most important component of a payment schedule is that payments be timed with work completed. This protects the homeowner and reduces the risk of contractors walking away from projects with homeowners having to double-pay (another contractor) to get projects completed.
2) Avoid excessive initial payments.
Some initial payment is required for the purchase of materials and services to start a project and for successive project components. However, I often see a request for excessive upfront funding. Sometimes this is broken out into 2 payments: a) upon signing of contract, and b) upon initiation of work. The danger of upfront payments is that payments are made, but no work has been provided. The larger the project, the lower the up-front payment percentage should be.
3) Tie payments to passed inspections.
When payments are tied to inspections, the subjectivity is taken away from determining whether a phase is complete or not, and the individual building trade inspector (building inspector, plumbing inspector, electric inspector, etc.) becomes the judge of task completion - not the contractor or the homeowner. A passed inspection also comes with a tangible "OK" from the building inspector - a passed inspection sticker. Inspection points represent critical milestones in the project work. Some examples:
rough plumbing and electrical inspections have to pass prior to calling for the rough framing inspection.
rough insulation inspection has to pass prior to walls being closed with drywall
final plumbing and electrical inspections have to pass prior to calling for final building inspection.
In NJ, final building inspection must pass prior to issuing the final payment to the contractor.
4) Create a punch list payment separate from the final inspection.
Many contractors end their proposed payment schedules with the milestone: Final Inspection passed. This however does not account for many of the remaining items that become part of a punch list. Inspectors generally are looking for safety-related completion items. Aesthetic considerations such as completed painting, completed tile, etc. will not be a deterrent for a passed inspection but would certainly reflect an incomplete project. I always recommend a Punch List payment that is separate from the final inspection payment. This punch list payment creates an incentive for the contractor to complete the project to the homeowner's satisfaction and expectation.