How does the escrow holdback agreement work?

Wondering about an escrow holdback? Here’s a concise guide that will help you explore the financial agreement in detail.

When buying a home, various things can affect or delay the closing process. It could be financing issues or property appraisal discrepancies. If repairs are holding up the closing, an escrow holdback might be the solution. 

It involves collecting extra funds at closing, which get refunded once necessary repairs are done. Essentially, it’s a tool to encourage quick fixes so both the buyer and seller can benefit. If you’re refinancing and your home needs minor repairs, an escrow holdback can also help you stick to your closing date. Before learning more about the escrow holdback process, let’s understand what an escrow account is. 

What is an escrow account?

Think of escrow as a middleman holding onto your money until something specific happens, like when you close on a property. In real estate, they use an escrow account to keep your home-buying deposit safe until everything’s finalized. After closing, you might still have an escrow account from each mortgage payment to cover payments such as property taxes and homeowners insurance.

What is an escrow holdback agreement?

In an escrow holdback agreement, aka repair escrow, funds are reserved during a home’s closing to finish repairs. Usually, the seller covers this cost, but there can be exceptions. The money sits in an escrow account until the repairs are done, and then it gets released. 

What are the advantages and disadvantages of an escrow holdback?

Here are the pros and cons of escrow holdbacks.

Which home projects qualify for an escrow holdback?

Keep in mind that not all transactions may allow for an escrow holdback. That said, no mortgage lender wants to fund a property that might harm its occupants’ health or safety.

Here are some repairs that could affect property value and safety and hence qualify for an escrow holdback.

• Patio problems
• Pest control
• Roof repair
• Septic tank issues
• Lawn sprinkler system problems
• Yard cleanup

How does an escrow holdback work in homebuying?

Adding an escrow holdback or repair escrow to the real estate contract involves an additional addendum outlining the repairs, their estimated cost, completion deadline, and payment details for contractors. 

Those opting for an escrow holdback can either get the work done or do the work themselves without compensation, saving money and retaining more control over the project.

To proceed, both the buyer and seller must sign the escrow holdback agreement before submitting it to the lender. If approved by the loan lender’s underwriter, the lender collaborates with the title company or handles it in-house to establish an escrow account.

Typically, the seller is responsible for funding the escrow holdback, often using proceeds from the property sale for repairs. Lenders may require the account balance to exceed the estimated repair costs for potential cost increases during the project. And, all repairs must be completed within a specified time frame.

After fixing the property, a final inspection verifies completion. If the repairs meet the satisfaction criteria, the escrow account releases the funds. The holdback amount financially motivates the seller (and sometimes the buyer) to address home issues promptly.

When is escrow holdback necessary?

It’s generally the loan lender who decides when an escrow holdback is necessary (or permissible) after a home appraisal. 

If the lender plans to sell your mortgage to a government-sponsored enterprise (GSE) after closing, they must comply with the GSE’s rules. For example, if the house repairs are non-structural, Fannie Mae buys the loan before the home is fixed. If it’s structural, the lender must show the property was fixed before selling your mortgage.

Here are some cases that require escrow holdbacks. 

FHA and VA loans

The Department of Housing and Urban Development (HUD), through the FHA loan program, aids home buyers but has its own escrow holdback rules. If you’re applying for an FHA loan, the property can’t need over $5,000 in repairs for an escrow holdback. If it exceeds that, you can consider a 203(k) FHA rehabilitation loan instead. 

VA loans, backed by the Department of Veterans Affairs, have similar guidelines but require 150% of repair costs upfront.

Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac are GSEs that buy mortgages from lenders to keep them financially sound, enabling more home loans. They only purchase conforming loans, which meet their standards. Conforming or conventional loans stick to set limits and need a credit score of 620 or higher. Nonconforming loans, such as jumbo loans or government-backed loans, don’t meet these standards.

State laws and geographic locations

Sometimes, the state you live in can cause delays in the home-buying process. That’s because every state has its own regulations regarding property appraisals. For example, in the South, termite inspections are very common and important before a deal is finalized. In such cases, escrow holdbacks come in handy. 

Lenders’ rules and regulations

Your lender could impose stricter repair conditions on real estate deals, making escrow a smart decision.  

What are the most important considerations about escrow holdbacks?

When using an escrow account, make sure your agreement is clear about the repairs, sale prices, repair costs, and when things should be done.

And, always pick a good contractor. This is crucial for making sure the repairs are done right.

Remember to keep good records of everything during the complete repair process, including bills, receipts, and inspection reports.

Last thoughts

In a nutshell, using escrow holdbacks for repairs is smart in real estate. It gives a structured way to deal with required repairs and keeps the house sale on track. When done right and with good planning, it’s a win-win for both buyers and sellers, making the whole home-buying process smoother and easier.

Read more: Why did my escrow go up?

Written by Ramona Sinha. February 19, 2024

Ramona is the Senior Content Writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. She has written articles covering a broad range of topics, such as real estate, lending and mortgage, finance, business, taxation, home designs, home improvement projects, decor concepts, and more. An avid traveler, she’s a digital nomad at heart and an animal lover from the depth of her soul.