What Is Escrow Holdback and How Does It Work?
October 12th, 2022
Let’s say you’re about to close on your new home and ready to sign the paperwork and take possession. However, work on the property hasn’t been finished, and the closing is approaching fast. In this case, you may want to consider an escrow holdback.
Escrow holdback is like an insurance policy, and the key is to put enough money in escrow to encourage the seller to finish the work.
This article explores escrow holdback in detail to help you understand whether this option might work for your particular situation.
What Is an Escrow Holdback Agreement?
An escrow holdback agreement is an arrangement where money is set aside at the closing of a property to finish the repairs, usually done at the seller’s expense. That said, money is held in an escrow account until the repairs are done. While this may sound like a good deal, it’s not available for every borrower in every situation.
Before approving an escrow holdback, the lender’s underwriter must review the appraisal and inspection reports. This is necessary to confirm that the sales price is met and that the house doesn’t show signs of deferred maintenance items that can affect safety and structural integrity.
How Does the Escrow Holdback Work?
Typically, the first step involves the buyer and seller’s agents negotiating the repair via an addendum to the purchase contract framed by the real estate agents and signed by all parties.
The escrow holdback agreement will likely outline the repairs the buyer or lender wants the seller to make, the timeframe for those repairs, and details about the payments to the contractor.
Then, this contract is sent to the escrow company and the lender to review the agreement. However, the underwriter of the loan will decide whether the escrow holdback will be approved. If so, the closing can proceed as planned, but this is not the case for all holdback requests.
Note that the lender may have conditions regarding the approval of a holdback, such as the completion of improvements within 180 days of the closing date.
Usually, the lender will establish an escrow completion account with the title company from the purchase returns equal to 120% of the assessed expenses for finishing the improvements.
However, not all transactions qualify for an escrow holdback as the criteria can vary between lenders, property, and type of transaction.
Common Reasons for an Escrow Holdback
Home Repairs
Home repairs are the most common reason for real estate transactions ending up in escrow holdback. This typically happens when the seller agreed to make repairs after the inspection, but they haven’t been completed before closing.
Although lenders prefer repairs to be made before closing, they can make exceptions when repairs need to be postponed because of bad weather. This could limit holdbacks to repairs that must be made outdoors, such as on the roof or in the yard.
Health and Safety Issues
Lenders usually check if the repairs impose a risk to the property or health and safety concerns to the occupants. These issues can determine whether the house is eligible for financing, with most lenders avoiding closing a loan on a property with issues like missing stairs, railing, or fencing.
The appraiser will note the more apparent issues and may suggest inspection by a professional. Then, the lender’s underwriter reviews the appraisal and inspection reports to confirm the sales price is met and whether the home needs repairs that impact safety, soundness, or structural integrity. If needed, he will require the repairs to be completed.
Depending on the repair, a lender may let the seller place money in escrow for a defect fix for a specific amount within a specific timeframe.
Note that these repairs can be expected or unexpected, and the seller might need the profits from the sale to finish the repairs.
Postponed Move Out
Escrow holdback can also happen if the seller hasn’t moved out by closing. In a home buying agreement where occupancy is given up upon closing, the buyer can move into the property once all documents are signed.
If you have such an agreement and the seller is unable or unwilling to move out upon closing, an escrow holdback may be your best bet.
New Construction
You may find yourself in an escrow holdback situation if you’re buying new construction.
Often, builders agree to a specific closing date, but the progress is delayed due to particular circumstances. In some cases, they can get an occupancy permit, allowing buyers to move into the property, although it isn’t finished.
While you want to trust your builders to complete the work, it may be safer to hold back some money in escrow.
Septic Systems
Many states demand the inspection of septic systems before closing. However, sellers may fail the inspection and require replacement, which tends to be expensive. That’s why many sellers who fail the inspection prefer to place funds in escrow to avoid postponing the closing.
Typically, lenders require a seller to hold back a minimum of 1.5 times the actual cost of replacement, ensuring that any overruns are covered.
Escrow Holdback Requirements and Limits for Different Loan Programs
Since not all lenders will agree to holdbacks, you need to understand when you’re entitled to a holdback so you can follow the right process and protect yourself from loss. That said, each loan program has specific guidelines when it comes to escrow holdbacks.
Conventional and FHA loans require completion within 180 days, and VA loans require completion within 90-120 days from closing.
Escrow Limits
- FHA: $5,000
- VA: the maximum amount isn't specified
- USDA: 10% of the final loan amount
- Fannie Mae: 10% of the appraised value
- Freddie Mac: 15% of the appraised value
What If You Don’t Qualify for an Escrow Holdback?
Unfortunately, there isn’t much you can do if your lender doesn’t approve an escrow holdback. Most likely, the closing date will be changed to make time for necessary improvements before closing.
Note that some lenders may not offer escrow holdback under any conditions because of the follow-up involved in closing the holdback or issues in completing the repairs within the time given.
Regardless of your situation, consider finding a lender that is eager to help you navigate the home-buying process. You can do this by checking out customer service reviews in addition to rates and terms.
An Escrow Holdback May Benefit You
With escrow holdback, you don’t have to push back the closing until improvements are completed, as this will allow you to keep your closing date and get the repairs done. If you’re in a similar situation, contact Lightspeed Escrow.
We are real estate professionals that created a climate where escrows aren’t a problem but a valuable tool for different real estate transactions.