Fixed-Price Contract

With a fixed-price contract, the general contractor provides an estimate covering labor, materials, profit margin, and a cushion for contingencies. If the contractor exceeds the budget for a foreseeable reason—underestimating the cost of the drywall installation, for example—he or she is on the hook.

That can be advantageous for the homeowner, but it can also affect the quality of the work if the contractor cuts corners to stay on budget—by ordering cheaper drywall, perhaps. Also, if the project comes in under budget, the contractor pockets the profit, which again could encourage subpar work.

Cost-Plus Contract

A cost-plus contract covers labor, materials, and profit but does not include an amount for contingencies. Instead, additional charges are passed along to the homeowner. That could put you at a disadvantage if you’re embarking on a complicated project that might reveal expensive unknowns. If the project comes in under budget, however, you keep the savings. What’s more, the contractor has no incentive to scrimp.

“If you trust your contractor, cost-plus will almost always save you money and give you the best quality product,” says Frank Montgomery, a contractor based in Franklin, N.C. Most cost-plus contracts come with a guaranteed maximum price, or a ceiling on additional charges. One downside: You’ll need to stay on top of the paperwork unless you have unquestioning faith in your contractor.

Editor's Note: This article also appeared in the June 2016 issue of Consumer Reports magazine.