the importance of contingency funds

[We have 59 draft posts in the cue that we worked on over the past year but never posted for one reason or another, and this is one of them {an important one at that}.]

Our first architect wasn't too keen on contingency funds. He thought we needed to invest those funds in the house because if we found ourselves at the end of the project with our contingency funds intact, we'd be upset. I disagreed and told him that we'd be elated if we had extra money at the end of the project. More moola for margaritas! And who wouldn't want a contingency fund? Based on what I've read, a little more than 99 times out of 100, you're going to dip into those funds (hopefully just a few toes and not a full-on belly flop).

Why have contingency funds? To be ready for the unexpected glitches and opportunities that invariably arise. If you are completely cashed out and leveraged to the gills to build your house, you could find yourself in a bad financial situation (an expensive unexpected glitch you can't pay for, such as finding King Tut's little brother's grave where your foundation is supposed to go) or not able to take advantage of an unexpected opportunity ("Look at that extra space... Let's put three toilets in the master suite!"). Oftentimes "contingency funds" and "landscaping budget" are interchangeable terms, and certainly the landscaping budget is there to dip into if absolutely needed. But if you want your house to be landscaped at the end of the project, it's good to have a different pot of gold to ladle coins out of.

It's difficult to estimate how much you need for contingency since you are planning for the unexpected. One of the builders we interviewed used a probabilistic approach for defining the contingency fund. Basically, he assigned a probability of certainty to budget categories based on experience and then added up those probabilities (extended to the associated budgets) to calculate the contingency, something we, as a scientist and engineer, loved him for. (Not-so-brief aside: When we got married, we used a probabilistic approach to invite folks to our wedding. We aimed for 100 attendees at the wedding and reception. For each person we invited, we assigned a probability [100 percent chance of attendance for mom = 1 attendee; 10 percent chance of attendance for Uncle Sammy = 0.1 attendee] and then added up the probabilistic attendees until we had 100 total folks "attending". Using that approach, we invited about 250 people and ultimately had 102 come! Geek love, baybee, geek love!).

We chose to set aside five percent of the construction budget as contingency, and thank goodness we did. We've had some minor building glitches ka-ching our budget, but nothing like the highway robbery of the change orders for the electric. Having the contingency also allowed us to upgrade or add some additional features to the house (many of which are in those electric change orders). For example, we're looking at not only wooding the ceiling and soffits in the living room area, but also for the back entry areas as well, a real nice upgrade that made a lot of sense once we saw the house go up.

There are always opportunities to upgrade, but you need to remember to pace yourself. Adding the heliport during the first week of construction may wipe out your contingency funds. Not good if you need those funds later. And if you do set up a contingency fund, it's best not to virtually spend it before the end of the build. It's a lot more painful (and emotionally traumatic) to let those funds go if you've already spent the money in your mind on a new television set. Assume that they will be gone. And if they're not, margaritas are on me!

Postnote: We set aside 5 percent of our build budget for contingency (which is a lot of money...) and also had the landscaping, rainwater harvesting, and solar budgets to fall back on, all outside the construction loan with the bank (which, in total, is even more money...). Total contingency charges amounted to 7.3 percent of the total construction budget; however, this included voluntary upgrades focused on the landscaping. If we just look at paying for the surprises that needed to be dealt with during the build, our contingency payments amounted to 4.1 percent of the total build budget. This drops to 2.6 percent if we factor in the credits we received from some of the changes we made. Friends, that ain't bad. Better attention to bidding details on the front end (by us and the builder) might have reduced that to 1.2 percent.

Bottom line: Have a contingency. It hard to know how big one should be since it will vary from project to project and builder to builder, but I'd recommend at least 5 percent.

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