Escrow holdback for repairs: FHA, VA and conventional

How does an escrow holdback for repairs work?

An escrow holdback for repairs lets you close on a home before the work is finished. The lender holds the repair money and pays it out as the work gets done. Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and Fannie Mae conventional loans each allow a version, with different rules. Ask your loan officer which one your lender offers before you agree to close with repairs still open.

Key takeaways

• FHA escrows only when the home is "habitable and safe" at closing, and the funds must cover the full cost.
• A Limited 203(k) finances minor, nonstructural repairs, with total rehabilitation costs capped at $75,000. A Standard 203(k) starts at $5,000 and needs a 203(k) Consultant.
• On a Fannie Mae loan, only minor items can go into escrow, and only if your lender agrees.

How does an FHA repair escrow work?

FHA's rulebook is Handbook 4000.1, from the Department of Housing and Urban Development. Its Repair Completion Escrow Requirements, section II.A.6.a.viii, let the lender escrow for "alterations and repairs that cannot be completed prior to loan closing". There is a condition: the home must be "habitable and safe for occupancy at the time of loan closing". If an open repair leaves the home unsafe to live in at closing, this escrow is not an option for it.

The escrow has to cover the whole job: "Repair escrow funds must be sufficient to cover the cost of the repairs or improvements."

When the work is done, the lender "must certify on form HUD-92051, Compliance Inspection Report, that the incomplete construction, alterations and repairs have been satisfactorily completed."

Which repairs does FHA require?

The FHA appraiser proposes that list, with a cost to cure for each item, not your home inspector. Section II.D.3.n limits it to repairs needed to "maintain the safety, security and soundness of the Property". The other two aims are to "preserve the continued marketability of the Property" and "protect the health and safety of the occupants". "Cosmetic or minor repairs are not required."

Your lender has the final word. "Regardless of the Appraiser's suggested repairs, the Mortgagee will determine which repairs are required." Items the appraiser skips can still go on your repair request.

Can an FHA 203(k) loan pay for repairs from your inspection?

Yes. A 203(k) is its own FHA loan. It can "purchase and rehabilitate a Structure and purchase the Real Property on which the Structure is located". The repair costs are financed in the loan. Section II.A.8.a sets out two versions.

Both lists include "repairing/replacing plumbing, heating, AC, and electrical systems". Both include "installing smoke detectors". The Limited version rules out "repairing, reconstructing or elevating an existing foundation". It also rules out work that keeps you out of the home "for more than a total of 30 Days during the rehabilitation period". Foundation work belongs in the Standard version.

Tell your agent early if you want a Standard 203(k). Section II.A.8.a.vi(H) says the sales contract must state "that the Borrower has applied for Section 203(k) financing" and be "contingent upon mortgage approval".

How does a VA escrow holdback for repairs work?

On a VA loan, repairs can be finished after closing through an alteration and repair loan. The VA Buyer's Guide sets out how it works:

• "VA allows improvements to be included in the value and completed after closing of the loan."
• "Loan proceeds are paid out to the builder and/or contractor during the alteration/repair period."
• The lender "must obtain written approval from you before each disbursement or draw payment".
• The work "must bring the home up to the VA's minimum property requirements".
• Your contractor must "register with VA to obtain a VA builder identification number".

A cushion for surprises is optional. "The maximum contingency reserve is 15 percent of the alteration and/or repair cost."

VA's guide also warns that "Not all lenders are able or willing to close alteration and repair loans". Ask at application, not after the appraisal.

Can a conventional loan close with repairs unfinished?

Only for small wear-and-tear items, if the loan is going to Fannie Mae. Under its Selling Guide B4-1.2-05, "the lender may escrow for these items at its own discretion". The items must "not affect the safety, soundness, or structural integrity of the property". Its examples include "worn floor finishes or carpet, minor plumbing leaks, holes in window screens".

Safety and structural items are different. The guide says "the lender must verify completion before the loan is sold to Fannie Mae". Ask your loan officer whether that means before your closing.

Who pays for the repairs, and how much can FHA add?

If you use a 203(k) or VA's program, the work is financed in your mortgage. On a regular FHA loan, section II.A.2.a.v lets the lender add repair costs to the sales price. Three conditions apply:

• "the repairs are required by the Appraiser to meet HUD's MPR", its Minimum Property Requirements
• "the repairs are paid for by the Borrower"
• "the sales contract or addendum identifies the Borrower as the party responsible for payment and completion of the repairs"

The amount added is "the lesser of" three figures:

• "the amount by which the value of the Property exceeds the sales price"
• "the Appraiser's estimate of repairs"
• "the amount of the contractor's bid"

Say the home is priced at $300,000 and appraises at $310,000. The appraiser estimates $12,000 of repairs and your contractor bids $9,500. The three figures are $10,000 ($310,000 minus $300,000), $12,000 and $9,500. The contractor's bid is lowest, so it is the most the lender can add.

If the seller won't finish repairs before closing, you can ask for a credit. Or you can finance the work with a 203(k) or VA alteration and repair loan. The three-way comparison helps you pick. Your contract sets who pays and by when, so confirm the terms with your agent or attorney.

Can you do the repairs yourself?

Not for pay. On a 203(k), your lender has to approve it and you sign a Rehabilitation Self-Help Agreement. Even then, "The Borrower must not be reimbursed for labor costs", and the escrow pays for "materials only" on your items. On a regular FHA loan, "The cost for Borrower labor may not be included in the repair escrow account."

Is an escrow holdback the same as a seller credit?

No. A holdback keeps the repair money in escrow until the work is done. A seller credit is "the amount the seller has agreed to contribute to your closing costs", in the Consumer Financial Protection Bureau's words. See how a repair credit works at closing.

How much should the escrow be?

Enough to cover every repair on the list, priced line by line. Get contractor bids on the big items. Kept prices every line of an inspection report for $79, usually under 4 hours, and marks the ones that need a professional quote.

Before you agree to a holdback amount, upload your inspection report to Kept and see what the open repairs are likely to cost.

Sources

• HUD Handbook 4000.1, Single Family Housing Policy Handbook, Update 18
• VA Home Loan Guaranty Buyer's Guide
• Fannie Mae Selling Guide B4-1.2-05, Requirements for Verifying Completion and Postponed Improvements
• Consumer Financial Protection Bureau, Closing Disclosure explainer