No one wants to reschedule closing on a property. But in some cases, that’s the only option when home repairs crop up or are delayed. Maybe the sale was contingent on those repairs, so the closing had to be paused.
Whatever the case may be, escrow holdbacks were designed with this common closing day hiccup in mind.
An escrow holdback agreement allows the property to close on time while maintaining home repair contingencies. It really is a Hannah Montana best-of-both-worlds kind of situation!
Defining Escrow Holdbacks
So what exactly is an escrow holdback (aka repair escrow)?
An escrow holdback happens when money is “held back” in escrow at closing for required repairs. Once the repairs are completed, the money is released to the seller. The money, which is set aside from the proceeds of the home sale, is held in the escrow account to motivate the seller to complete repairs.
Once the required repairs are completed and the home is reinspected and reappraised, the money that was held back in escrow is paid out to the seller.
How Does an Escrow Holdback Work?
The lender usually holds back 120% of the repair costs from the home’s purchase price. Going over the estimated repair costs motivates the seller and provides a little extra funding in case there are delays or extra expenses.
Think of it as insurance for the buyer. With an escrow holdback, the buyer can close on a house knowing that either the repairs will be completed by the seller within a specified time frame or they’ll have the money they need to make the repairs after closing.
Let’s say a home gets sold for $255,000, and it needs $5,000 in repairs. The lender would hold back $5,000 plus $1,000 (the extra 20%) for a total of $6,000 in escrow. The lender subtracts the $6,000 from the sale price and deposits it into the repair escrow account.
The $6,000 gets released to the seller once they’ve completed the repairs, and the home is reinspected and reappraised.
Why Use an Escrow Holdback?
There are a variety of circumstances that would trigger an escrow holdback. Here are some of the more common circumstances:
- There may be damage to the home from a recent natural disaster.
- Construction or repairs can’t begin because of weather conditions. (For example, you want to close during the winter, but the work can’t start until spring.)
- Construction or repairs are delayed because you’re waiting on approvals, materials or labor, but you want to close soon.
- The seller may not have the funds to complete repairs until the house is sold.
Home Repairs Eligible for Escrow Holdbacks
Lenders are particular about what types of home repairs or construction qualify for an escrow holdback. Issues that affect the health, safety or structure of the house are usually not eligible for escrow holdback.
Escrow holdbacks typically apply to weather damage from events like snowstorms or hurricanes or outdoor concerns like decks, landscaping, fallen gutters or pest control. Escrow holdbacks are also commonly used for septic systems.
Most lenders won’t close on a home that has severe health, safety or structural issues because lenders are normally not in the business of handing out loans for unlivable homes.
Who Is Responsible for the Escrow Holdback?
Ultimately, the buyer and the seller both share responsibility for the escrow holdback. To qualify for an escrow holdback, the buyer and seller must sign the real estate contract with the escrow holdback agreement added in.
The seller, however, is responsible for making the necessary repairs to the property within the budget and time frame both parties agreed to.
How Does an Escrow Holdback Work?
There are a few steps to take to get an escrow holdback for repairs.
- Update the contract: First, you’ll need to add an escrow holdback addendum to your real estate contract. The addendum should outline the repairs, the estimated cost, the deadline and the plan to complete the repairs.
- Sign and file: The buyer and seller must sign the amended contract and submit it to the lender. If the lender approves the holdback, they’ll deposit the holdback funds into the escrow account.
- Make the repairs: The seller is responsible for completing the repairs within the proposed budget and time frame.
- Inspect and appraise: Once the repairs have been completed, the property will need a final inspection and appraisal. Once the work has been approved, the funds that were held back are released to the seller.
Requirements for Escrow Holdbacks
While most lenders are open to using escrow holdbacks, eligibility will depend on the type of loan you have and the lender’s guidelines. Let’s take a look at different loan programs and their restrictions on escrow holdbacks.
Conventional loans conform to the rules and regulations set out by Fannie Mae and Freddie Mac (two government-sponsored entities that purchase mortgage loans). Both of these entities have slightly different regulations around escrow holdbacks.
If your lender wants to sell your mortgage to Fannie Mae or Freddie Mac, they must follow their rules on holdbacks, including their limits. Fannie Mae and Freddie Mac’s maximum escrow holdback amount is 10% of the appraised value of the home.
To qualify for an escrow holdback, the required repairs can’t exceed 10%, and the repairs must be completed 180 days after closing.
Like conventional loans, the FHA requires that repairs are completed 180 days after closing.
Department of Veterans Affairs (VA) loans don’t specify a maximum escrow holdback amount.
VA loans require any repairs to be completed within 90 – 120 days after closing. Your deadline will depend on your agreement.
Other potential restrictions
Your lender, state or region may have other requirements for escrow holdbacks. These are especially notable when it comes to inspection requirements. Inspection requirements can vary by location and are based on a specific region’s concerns. For example, states like Texas, Oklahoma, Arkansas and Louisiana require a termite inspection to close on a house.
That’s why it’s a good idea to talk to your lender to see what state laws and geographic concerns may affect your escrow holdback.
Escrow Holdback Alternative
If your lender doesn’t approve escrow holdbacks or the damages are a little beyond the requirements, there’s an alternative: a seller credit.
With a seller credit, the buyer becomes responsible for repairs on the home. In this scenario, the seller reduces the home purchase price by the cost of the repairs. It’s essentially a discount that gives buyers the funds they’ll need to make repairs.
Even if an escrow holdback isn’t in the cards, with a seller credit, you can make the needed repairs on the property, and the seller can sell their home.
Close With Confidence
With the assurance that an escrow holdback or seller credit gives you, you don’t have to wait around for repairs. You can close with confidence, knowing that the needed repairs will be completed in a timely manner.
It really is the best of both worlds!
Fannie Mae. “Selling Guide.” Retrieved January 2022 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B4-Underwriting-Property/Chapter-B4-1-Appraisal-Requirements/Section-B4-1-2-Documentation-Standards/1032991871/B4-1-2-03-Requirements-for-Postponed-Improvements-02-06-2019.htm
Freddie Mac. “General property eligibility requirements.” Retrieved January 2022 from https://guide.freddiemac.com/app/guide/section/5601.2
U.S. Department of Housing and Development. “Appraising and Financing HUD Real Estate Owned (REO) Properties With FHA-Insured Financing.” Retrieved January 2022 from https://www.hud.gov/sites/documents/00-27ML.PDF
U.S. Department of Veterans Affairs. “Chapter 12 Minimum Property Requirement.” Retrieved January 2022 from https://benefits.va.gov/WARMS/docs/admin26/m26-07/Ch12_Minimum_Property_Requirement_NEW.pdf