At the request of several readers, this article is a repeat of an earlier article containing suggestions about the proper procedures to the followed when building new home in Texas. Many of the suggestions listed below also apply to the renovation of an existing home. With respect to a new home, the suggestions relate to the purchase of a lot and then the construction of the home itself.
First, identify the location of the property, and determine its history; e.g. has the area ever flooded, is it in a flood plain, is it near an industrial area or a potential industrial area; how is it zoned; and if it is in an existing subdivision, what are the requirements and restrictions for the subdivision.
Second, before the lot is purchased, consider purchasing title insurance. It is important to ensure that the owner has the right to sell good title to the property. Inquire about any factors that affect the title such as road and pipeline easements, and oil leases that may be located near or affect the property. Consideration should also be given to having the property surveyed.
Third, determine whether the proposed home will fit on the property. What are the building requirements, such as does it have to be brick construction, have a certain type of roof, or be a certain number of square feet.
Fourth, contact an architect or builder with a proven reputation. Develop very detailed specifications, once satisfied with the specifications; ask for bid(s) for construction. If the bids are too high, consider modifying the specifications.
Fifth, negotiate a written contract with the builder which incorporates the specifications, and sets a beginning and ending date for construction. It should also contain a written warranty for work performed by the contractor. The warranty is usually for a year. If bank financing is required for construction, take the contract to the bank to determine if the bank will approve an interim construction loan. If the contractor provides the interim financing, there is no need for the homeowner to approach a bank for a construction loan; but it is necessary for the homeowner to obtain approval for a permanent loan following the completion of construction.
Sixth, a written contract is required for the construction of a home in Texas. It is essential for the written contract to be executed prior to the beginning of any work – repeat any work – by the contractor. It is also imperative for the bank’s construction mortgage (whether the loan is to the homeowner or the contractor) to be recorded with the county clerk prior to the beginning of any work. Do not under any circumstances allow any work (not even a spade full) whatsoever to begin prior to the execution of the contract and the recording of the construction mortgage.
Seventh, once construction begins, never change any part of the contract unless the change is in writing and agreed to as to the price of the change. Any modification of the contract is known as a “Change Order.” Both the contractor and the homeowner should sign the Change Order.
Eighth, the homeowner should never give any instructions or become directly involved with a subcontractor. The homeowner should always deal direct with the contractor sometimes referred to a “prime contractor.”
Ninth, the construction contract will provide for incremental payments to the prime contractor during construction. For example, contract will state that a certain sum is owed when the slab is poured, when the framing is complete, and when the electrical is complete. As advancements are made, the homeowner should have a process to ensure that each subcontractor is paid for work thus far performed. If a bank is involved as the interim lender, it will have a procedure to be followed to ensure payment of the subcontractors. Interim lending involves much more risk than permanent lending.
Tenth, during the construction stage, the homeowner or the bank should never advance more than 90% of the contract price to the contractor. If the construction contract is successfully completed, there should be a retainage fund at least equal to 10% of the contract price. The purpose of the retainage fund, sometimes referred to as “retainage” is designed to protect the homeowner from claims made by unpaid subcontractors. For example, if the electrical subcontractor is not paid by the prime contractor, the electrical subcontractor will file a lien against the homeowner’s property which may be foreclosed upon if action is not taken. In such a case the homeowner will not be able to close on the permanent loan and occupancy of the home will be delayed (or held hostage). This is where the retainage fund becomes important. If the homeowner has withheld 10% of the construction contract price, and has not established a direct relationship with (for example) the electrical subcontractor, the lien of the electrical subcontractor will attach to the retainage fund rather than the property. Stated another way, the electrical subcontractor must look to the retainage fund for satisfaction of the debt, and cannot establish a valid lien against the property. If a subcontractor files a lien during the construction phase, no further advancements should be made to prime contractor.
Eleventh, if the prime contractor defaults during construction, it will be necessary for the homeowner to establish a new contract contractor with another prime contractor. This will increase the cost of the home, and the bank should be involved in the process of selecting a new prime contractor. The bank should be notified immediately if there is any problem with the prime contractor.
Twelfth, when the prime contractor is of the opinion that all work has been performed pursuant to the terms of the contract, the contractor will ask the homeowner to sign an agreement to that effect. Before signing any such agreement, the homeowner and the contractor should conduct a thorough “walk through” of the home. A homeowner should never sign a completion certificate unless the homeowner is satisfied that all work has been truly performed, and that all subcontractors have been paid. This means that the homeowner should obtain a sworn “all bills paid” affidavit from the contractor. This is where the homeowner is at risk because if the contractor’s affidavit is false (as is so often the case), the unpaid subcontractors may attempt to lien the property. The reason why the contractor wants an executed “all work performed” agreement is because the contractor wants a release of the money in the retainage fund; and, if the retainage fund is released and a subcontractor remains unpaid, the subcontractor may place a lien against the property.
Banker Phares is a John and Karen Mast Professor at SFA. He teaches financial planning and is board certified in estate planning and probate law.