10 Tips for Building Your Dream Home

So ask for extensive references, then make sure you contact them. Ask detailed questions. You should also inspect two or three homes that were constructed by the builder.

5. Manage subcontractor risk. As I detailed here, a builder's relationship with subcontractors is a huge risk factor. In order to make sure they are paid, subcontractors will place liens on your property. If the builder fails to pay a subcontractor, the lien remains, even if you already paid the builder for this work. So if the builder goes bankrupt, you could wind up paying twice for the same work. It is very important to get releases of liens from all subcontractors as they are paid.

6. Choose the lender carefully. With construction loans, lenders don't just write a check to the borrower; they disburse a series of payments called "draws" directly to the builder as various stages of construction are completed. This means you, the borrower, are giving up your ability to hold back payment if you are unsatisfied with the work.

That's why it is important to choose a local bank with extensive experience in residential construction. As when choosing a builder, you should ask for references and follow up with detailed questions. You can also use TheStreet.com Ratings Screener to check a lender's financial strength. An institution rated D+ or lower has a financial weakness that could affect your project.

If you feel it's important that you retain the ability to withhold payments for unsatisfactory work, you may want to consider alternative financing, such as a home equity loan or line of credit. If so, be prepared. You will have to take a very active role overseeing the project yourself.