Well the first step is you need a picture that follows the rules. The rules can be found in the Art Team's forum.
Then to apply a custom image to an NPC you must collect some Combine Points (CPs).
Once you have 500 you must click on the CP link to exchange them. It is located on the general information tab on the right hand side of most screens.
CPs is the number located underneath your Avatar, XP, and Level.
Once you are there click "Exchange CPs"
In the custom image section on that page there will be various options of what to apply an image too. Click the first drop down arrow that says Entity Type and select NPCs.
On the next drop down box select private image and put in the URL for your custom image. (Which must be located on Photobucket or the such)
Hit "Exchange" and the Art Team will review it. If it follows the rules it will be accepted.
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To answer your other question - a custom NPC can be hired from a Civic Center for a sum of credits.
Also, if you click the Edit NPC button in the NPC part of the inventory, there will be a few images that you can choose from that are hosted on the SWC server. These are free, but everyone can use them - depends on how unique you what them to be.