When you first make an offer on a home and produce an earnest money deposit those funds are held by a third party and released when the sale concludes. Funds are held in escrow at the escrow company that will also oversee the settlement when you close on your home. Sometimes, though not all that often, not all of the funds are released but instead held until the seller of the property performs certain functions to fulfill the terms of the sales contract.
Let’s take a closer look at the term “escrow holdback” and understand what it is and how it works.
When you see a home you really like and you decide to make an offer on it, your agent will present your offer to the seller who will then decide whether or not to accept. You might go back and forth a couple of times but ultimately you come to an agreed upon price. To seal the contract you’ll provide your earnest money which will be held by the escrow company. You already have your preapproval from your lender and the closing is to take place within 30 days but your lender may not order the appraisal until your property inspection has been completed.
Why the wait?
When you send your money to the lender to pay for the appraisal and the appraisal is ordered, there’s no way the appraiser will refund the money once the appraisal has been completed. The appraiser has completed the appraisal order and if something comes up in the property inspection that will cause you to pull out of the deal, you now have an appraisal on a property you’re never going to own. That’s why lenders wait until your inspection has been completed before getting too much further into the approval process.
After your contract is signed by both parties one of the very first things you’ll do is order an inspection. A property inspector is different than the appraiser. The appraiser determines the market value of the property by comparing recent sales of similar properties in the area while the inspector will perform a physical evaluation of the home doing things from flipping light switches, making sure the dishwasher and other appliances are in good working order and looking for any physical defects in and around the home.
After a few days, the inspection report has been completed and delivered to you. Most times the inspection report will present things that need to be addressed or fixed but nothing that will kill the sale. For example, the inspector might point out the sink disposal doesn’t work. That’s not something that buyers will balk at and pull out of the deal. But if the inspection report is returned and says wooden deck in the back yard is rotting and dangerous. Such a condition might not only give a buyer pause but also cause the mortgage company to decide not to lend on a home with such physical damage. Minor issues can be fixed later or the seller might agree to make the repairs before the closing takes place.
Let’s look at that wooden deck again. You explore further and get an estimate from a couple of carpenters about how much it will cost to repair or replace the deck. The estimate comes back at $3,000. You get back to the sellers and ask they reduce the sales price for the amount of the repairs. If they say “yes” then the lender will proceed with the approval but before you close the lender will order an inspection of the property to verify the deck repairs have been completed before the closing date. If so, your loan moves closer to the settlement table. If not, the closing won’t take place because the contract says the seller will make the repairs before the closing date and the lender wants the deck fixed before issuing a loan. If the deck is not repaired and it’s closing time, there will be no deal and it’s very likely the home will fall out of escrow altogether. Or, the sellers refuse to make the needed repairs. Again, the deal falls apart.
Unless you request an escrow holdback from your lender.
Escrow Holdback How They Work
An escrow holdback is an additional amount of funds set aside to make needed repairs on the home and are taken from the seller’s proceeds. Going back to our wooden deck that needs repairs, let’s say there is an escrow holdback agreement to have the escrow company keep the $3,000 from what the proceeds of the sale provides to the sellers. The closing occurs and the loan is funded while the repairs are being made to the deck. Once the deck is completed, the lender orders an inspector to visit the property once again to make sure that yes, the deck has been repaired. Once that documentation is reviewed and approved by the lender, the lender instructs the escrow agent to release the remaining $3,000.
Escrow holdbacks aren’t common and not every mortgage company allows for them. We at Home Point Financial do but under certain conditions. First, the holdback request must first be approved and determine the needed work will be completed within two weeks. Major repair work such as foundation or roof problems will not be approved. The maximum amount of the escrow holdback must be no greater than 1.5 times the cost of the repair or improvement and can represent no more than 10 percent of the current appraised value of the property.
Escrow holdbacks can be a convenient option for those who wish to buy a particular home but don’t want to lose the deal because of repairs that need to be made to the home prior to a loan closing. It’s not always the case where an inspection report finds items that need to be attended to and can’t so the entire deal falls out of escrow. Instead, an escrow holdback might be the ideal solution.