Building a home is entirely different than just buying a new home. Understanding how construction financing works can be difficult. Moreover, several legal issues can arise when dealing with the contractor who is building the home.
Financing the construction of a new home
Most people are familiar with a traditional mortgage set-up. A bank agrees to loan money to a borrower in exchange for the promise to pay the money back. The home serves as collateral for the loan, always there for the repossessing if the borrower defaults on the loan. But what about the borrower who wants to build a home? How does financing for that work?
A construction loan is a short-term loan; many lenders loan the money for a specific period up to a year according to Citizens Bank. The loan operates as a line of credit during the construction phase. Once the new home is completed, the construction loan can be converted to a regular mortgage, since now the house is around to act as collateral. Alternatively, the bank might decide to issue a mortgage to the homeowner and a construction loan straight to the builder.
Borrowers should only deal with trusted lenders and may want to consult with a real estate attorney to review the paperwork and contracts that come with the construction financing.
Once financing has been obtained, it’s time to get down to the business of actually building the house. Assuming there are approved plans and specifications from an architect or structural engineer, this step will involve finding a general contractor who will manage the project.
Your state’s Attorney General’s office, easily discoverable online, is responsible for handling complaints about contractors, so it’s the perfect place to start in researching potential candidates.
The Attorney General in Texas, for example, has some specific advice for vetting a potential contractor:
- Verify that the contractor has a physical address. Many use cell phones, but a physical address is important.
- Get more than one bid on the work, but beware of any “low-ball” bids.
- Ask for references and check those references. This is also a good time to research any complaints with the state.
The relationship between the homeowner and the contractor should be memorialized in a written contract. States may require certain terms be included; for example, in Maine, every construction contract must include, among other provisions:
- Work dates (also critically important for the construction loan)
- Price and payment, including any payment schedules
- Description of the work to be performed
- Dispute resolution procedures
- Language about change orders
Keep in mind that the construction contract is, like any other contract, negotiable. You do not have to simply accept a standard or boilerplate contract, even if the contractor assures you that this is “how it’s done.” Finding an attorney familiar with construction agreements can save money in the long run.
More about warranties, dispute resolution, and change orders
There are two types of warranties involved in the building of a new home: express and implied. An express warranty is exactly what it sounds like, a warranty written in exact terms for the contract.
An example would be in Maine, which requires the following language: “In addition to any additional warranties agreed to by the parties, the contractor warrants that the work will be free from faulty materials; constructed according to the standards of the building code applicable for this location; constructed in a skillful manner and fit for habitation or appropriate use.”
If the state did not require that language, fit for habitation would be an implied warranty, meaning there is no specific language in the contract, but common law holds that it is so core to that type of contract that the warranty is implied by the contract itself.
Those words, “fit for habitation” are legal terms of art that can mean more than just the obvious. If there is a dispute about that standard, an experienced real estate or construction attorney can provide assistance.
Disputes commonly arise during construction. Most can be resolved directly between the parties. However, if that doesn’t work, the contract should have language that specifically outlines how disputes will be handled. Often this will involve something other than going to court. Alternative dispute resolution options include binding arbitration, a quasi-judicial process where an independent party hears arguments and then resolves the case quickly and privately.
Changes to the plans or drawings, or to the scope of work expected from the contractor, are common during the construction process. Each of the changes should be written into the contract by way of an addendum to avoid any disputes in the future.
Ask for guidance
Whether from the Attorney General’s office or an experienced attorney, help and resources are available. Building a dream home does not have to turn into a nightmare.