The “Double (Stuff) Contingency” on Construction Loans and How to Avoid It.
Custom contracts need a buffer…not a double-stuff. A contingency on top of a contingency is just way too much!
If you’re building a custom home you should carry a contingency. It’s smart risk management for the borrower, the builder, and the bank. A contingency is a buffer to the budget, and usually ranges from 5–10%, usually included in the total contract price. Creating a contingency is important as it provides flexibility to handle cost increases, change orders, and unknowns. The trouble starts when a lender layers on a second, or overlay contingency. That “double duty” silently inflates capital required to close, squeezes your appraisal, and can even knock your DTI out of bounds.
What goes wrong when the bank adds its own contingency
A) Your down payment requirement increases more than it should
Most lenders size the contingency in relation to the total cost o the contract. Since the pandemic, most builders work off a “cost plus” contract. This is perfectly acceptable, and adding a continency into the contract or having healthy reserves on the sideline insulates the deal accordingly. However, if a bank adds, say, a 10% overlay contingency on top of your contract’s 10% to accommodate a variable contact, your “cost” number balloons up which requires more money at closing to close.
For Example…
Let’s assume your base cost, not including the land is $900,000. Then add a 10% in-contract contingency for a total budget of $990,000.
Usually this is enough, but lately we have seen some lenders overlay and additional 10%. This increases the cost to $1,089,000 as the full “underwrite cost.”
If the loan is capped at 80% of cost, that extra $99k forces $79,200 more cash at closing for risk already addressed by the contract contingency.
B) Appraisal math gets tougher
Construction appraisals are completed “subject to completion per plans & specs” as finished today. Inflating the budget with a lender overlay doesn’t raise value, that is determined by the comps. As a result, the gap the appraisal needs to cover, which can push LTV higher than expected or force late stage budget surgery. Some lenders like to see 20% down and even more lenders like to use the lower of the appraised value or the total cost. Even if the bank has additional flexibility with the loan-to-value, it could force mortgage insurance, or a higher rate for the added risk.
C) Qualifying gets needlessly tight (DTI + taxes)
If the overlay swells the loan amount or the lender underwrites payments against a padded budget, your qualifying payment rises. With interest rates hanging in the 6 percent range, the round figure cost per $100,000 equates roughly to $600 per month. The next “X” factor is the estimated property taxes. That’s part of the danger of increasing the budget. Lenders have the habit of using a 1% property-tax placeholder for property taxes. It works well for states like Missouri, North Dakota, or Oklahoma. However, for Arizona, that could be another double whammy as Maricopa county often runs closer to 0.5%. Effectively, your DTI is penalized by assumptions, not reality.
The fix: keep the contingency where it belongs (while adding more flex)
Leverage a fixed-price contract with a defined 10% contingency inside the contract
That satisfies legitimate unknowns without inviting a second, lender buffer. It makes more sense to include it within the contract, stacking it on top is completely unnecessary.Offer documented capital reserves
If the lender wants extra comfort, present liquid reserves as the safety net. Reserves cover any tail risk without inflating loan amount, appraisal hurdles, or any potential increase on cash to close.Underwrite state-appropriate property taxes
The property taxes should be based on the property taxes from comparable sales. If the values is based on sales, so should the property taxes. Most counties offer data based on benchmarks determined by assessed value. 1% is still slim for a state like New Jersey and unrealistic for a state like Utah. Use the documented values instead of a blanket amount. Small change, big DTI difference.Partner with a lenders that offer “float-downs” for the perm loan
One of the principal advantages of a single close construction loan is the ability to lock in the rate at closing. Rates will be higher, lower, or the same when your home is ready for delivery. If there is a 30% chance rates may improve, partner with a lender that offers a free float down at loan conversion. Its a win for you and the lender saving you from an immediate refinance. The prospect of utilizing a float down is likely in a declining rate environment.
A simple, real-numbers walkthrough
Scenario A (single contingency):
Contract price (incl. 10% contingency): $990,000
Max loan: 80% of cost = $792,000
Cash to close (excluding land/fees): $198,000
Scenario B (double contingency):
Bank overlays +10% on top = “@” $1,089,000
Max loan 80% = $871,200
Extra cash required: +$79,200 vs. Scenario A
Exposes Appraisal, Qualifying Payment, Property Taxes, Reserves
That’s real money for “protection” you already had.
Why this matters right now
Yes, volatility is still in the air, but isn’t what it was a few years ago, so overcommitting to unknowns is harder to justify. Best practices include a heart to heart discussion with your builder and murphy’s law. If tariffs are a factor, find out ways to mitigate them and perhaps utilize a heathy draw at closing to lock in material costs. For some 10% may be just right, for others 6% should be perfect. The amount should come from you and your builder, not the lender. Every unnecessary dollar in a padded budget increases down payment and qualification stress without improving the results. Keep contingency precise & contract-based, not duplicated.
Checklist: how to keep your deal tight
Fixed-price or contract with appropriate contingency included.
Written lender acceptance, no separate bank overlay if adequate reserves are documented
Taxes underwritten using state benchmarks/county tools/appraisal comparables- not a 1% boilerplate
Partner with lender that offers single close loan, & free float down as rate insurance
Disclaimer: This is general education, not legal, tax, or credit advice. Program terms and eligibility can change. Always confirm specifics with your lender, builder, and tax adviser.