Imagine that you are purchasing a house, have inspections performed, only to find repairs that are needed to be conducted. Depending on what was found and the loan program that you are using, these repairs could stop the purchase if unfixed. Other times you may not be in a position to want to except the house without the repairs being completed. If the seller is willing to make the necessary repairs, the sale can continue, but what happens if the seller does not have the funds to get the repairs completed prior to selling the house? Or what if the repairs are going to extend past the lock period for your loan? In these cases, the lender can approve what is called escrow holdback. This article will explain a little about what escrow holdback is and how it works.
Escrow holdback is basically funds that are held back from the proceeds of a sale, and held by the title company or closing agent, until after the repairs are completed. According to the Oxford Dictionary, escrow is defined as, “a bond, deed, or other document kept in the custody of a third party and taking effect only when a specified condition has been fulfilled.” In this context, the money in escrow belongs to the seller, however the monies will be used to pay the contractors that are performing the repairs in question. Any excess funds after the repair has been paid for will be dispersed to the seller.
What is the Process for an Escrow Holdback?
Once it has been established that there are repairs needed, the seller agrees to pay for the repairs as part of the sale, and that either funds or time is not sufficient to complete the repair prior to the loan closing, the loan originator can request an escrow holdback from the underwriters.
Each lender has different requirements for this requirement, and may have different guidelines for how the repairs are completed if approved. The loan originator can request an exemption to the repairs to be completed prior to closing accompanied with a request for escrow holdback. Most lenders will require 2 or 3 estimates from licensed and insured contractors that will perform the repair. Upon request of the escrow holdback, the loan originator will submit these estimates for review from the underwriter.
The underwriters will review the loan and request for escrow holdback to determine if it is feasible. Depending on the cost of the repair, and the possibility that more work may need to be performed in excess of what was estimated to completely repair, the underwriters may determine that extra funds should be held in escrow to allot for any unexpected circumstances, re-inspections, or additional fees that were not foreseen. This surplus could be as much as 150-200% of the highest estimate provided. This sometimes makes sellers skeptical if they do not fully understand that the money is being placed in escrow and technically still belongs to them.
What Happens After Escrow Holdback Approval is Granted?
After an approval is granted for escrow holdback, and all other conditions of the loan have been satisfied, the loan can proceed to closing. At closing, assuming that the property being sold holds enough equity to satisfy the repairs, the closing agent will holdback the amount that the lender has disclosed in their approval in to an escrow account. They may make provisions to release draws to the contractor if necessary to obtain permits and begin the work. This coordination will be between escrow agent (generally the title company) and the lender.
What Happens Once Repairs Have Been Completed?
Once the repairs have been completed, the lender will typically need proof the the repairs have been completed. This generally comes in the form of a re-inspection or an updated appraisal showing that the items to be repaired are in working condition. Once the lender is satisfied of the repair, they will coordinate with escrow agent to release remaining funds from the escrow holdback.
The escrow agent will then payout the remaining balance to the contractor that performed the repair. At that point, if there is still a balance in the escrow holdback account, those funds will be released to the seller.
What Are the Drawbacks of an Escrow Holdback?
This is a relatively no-risk situation for everyone involved. There is a slight inconvenience to the seller if the funds required exceed the amount of the estimates provided. In this case the seller would have to wait until after the repairs are completed before they would receive that portion of the proceeds from the sale. There is also a risk that there is not enough equity or proceeds from the sale to pay for the repairs. In this case, the seller would need to provide additional funds at closing in order to satisfy the escrow holdback requirement. If the seller is unable to provide those funds to escrow, the sale could ultimately fail.
To recap on Escrow Holdback…
You are buying a home where repairs are discovered during an appraisal or inspection. The seller agrees to make the necessary repairs as part of the sale, however there is not sufficient time or funds are not available for the seller to perform repairs before closing. After receiving estimates from licensed and insured contractors to complete the repair, the loan originator is able to request an escrow holdback. The escrow holdback allows funds to be held, after closing, in order to complete these repair post-closing. Once repairs have been accomplished, the lender releases the funds to the contractor and any excess funds held in escrow will be returned to the seller. Escrow holdback is not widely known, however it is a useful tool to keep a loan moving along so that the purchase transaction does not fail.
I hope that this article was helpful. Stay tuned for more articles to better educate you on the home buying processes.