Quick Answer: An escrow holdback is a practice where a portion of the seller’s proceeds is temporarily held by the lender after closing to cover necessary repairs or unfinished work. Once the repairs are completed and approved, the remaining funds are released back to the seller.
An escrow holdback is a financial arrangement that allows a home sale to proceed smoothly. It involves setting aside a portion of the seller’s proceeds to address any unfinished repairs or improvements post-closing. This measure is enforced by the lender to ensure the property meets certain standards. After the required work is done and verified, any remaining funds are returned to the seller.
Whether you are selling a property in Memphis, TN, Columbus, OH, or Temecula, CA, having a good understanding of how escrow holdbacks function can provide peace of mind and help you close the deal on time. This guide will explain what an escrow holdback is, why it is important for sellers, and how to navigate it during your transaction.
What exactly is an escrow holdback?
An escrow holdback occurs when a portion of the seller’s proceeds is temporarily held back at closing and put into an escrow account to cover necessary repairs or improvements that cannot be completed before closing. The funds are either deducted directly from the seller’s proceeds or placed in a separate account. Once the required work is done and meets the lender’s standards, the funds are released.
>> Read: How Escrow Works When Selling a Home?
What triggers an escrow holdback?
There are several reasons why a lender may require an escrow holdback. Understanding these reasons can help sellers anticipate potential delays. Here are some common causes:
- Appraisal issues: Safety or livability concerns identified by the appraiser that need to be addressed.
- Inspection repairs: Problems with the foundation, roof, or other essential systems that must be fixed before the property is habitable.
- Weather-related projects: Seasonal tasks like landscaping, painting, or exterior repairs that cannot be completed in certain weather conditions.
- Construction or renovation delays: New constructions or remodeling projects that are not fully finished by the closing date.
- Permit or title requirements: Pending permits, septic certifications, or legal documentation that must be finalized.
Who determines the necessity of an escrow holdback?
The decision to require an escrow holdback lies with the lender, as it is linked to the buyer’s financing. Even if the seller and buyer agree to post-closing repairs, the lender must approve the arrangement for the sale to move forward. If the lender does not permit it or if the repairs do not meet their standards, the transaction may be delayed until the work is completed.
Real-life scenario: In a case in Minnesota, a seller received an appraisal in December that called for exterior painting. As the work could not be done during winter, the lender approved an escrow holdback. Funds were retained at closing to cover the painting costs, and once the task was finished in spring and passed final inspection, the remaining funds were returned to the seller.
What sellers can expect during the escrow holdback process
To gain a better understanding of the escrow holdback process as a seller, it is essential to examine each key step and understand the seller’s role in it.
1. Identification of issues and agreement
When an appraisal or inspection reveals necessary repairs, the buyer and seller agree on the work and escrow amount, which is documented in a purchase contract addendum.
3. Approval of the escrow holdback agreement by the lender
The lender reviews the proposed escrow holdback agreement to ensure it meets their criteria and approves the arrangement.
4. Withholding of seller funds at closing
At closing, typically 100–120% of the estimated repair cost is withheld from the seller’s proceeds and placed in an escrow account.
5. Completion of repairs post-closing
After the sale is closed, the seller is responsible for completing the agreed-upon repairs or improvements within the specified timeframe.
6. Final inspection and release of funds to the seller
Once the repairs are done, a final inspection is conducted to ensure they meet the lender’s standards. Upon approval of the inspection, the escrow agent is authorized to release the remaining funds to the seller.
To prevent any delays in this final stage, Elliot J. Danziger of Danziger Legal PLLC recommends establishing the exit strategy upfront, stating, “The most critical detail for a seller in an escrow holdback agreement is a clear process for releasing the funds once the repairs are completed. The agreement should outline the required proof and include a definite response deadline to prevent indefinite delays if the buyer does not raise objections after confirming the completion of the work.”
>> Read: Understanding Escrow: A Comprehensive Guide to the Escrow Process
Advantages and disadvantages of escrow holdbacks for sellers
While sellers may not always have control over the necessity of an escrow holdback, as lenders may mandate one for financing approval, it is crucial to comprehend the benefits and drawbacks.
Pros of an escrow holdback
- Ensures timely closure: Helps in closing the transaction on schedule despite pending repairs, avoiding delays that could jeopardize the deal.
- Secures the deal: Provides reassurance to the buyer, reducing the chances of cancellation or financing complications.
- Facilitates lender approval: Ensures that the lender’s conditions are met, allowing the buyer’s financing to proceed smoothly.
Cons of an escrow holdback
According to Michael R. Nerenberg, Esq., Senior Partner at Borah, Goldstein, Altschuler, Nahins & Goidel, P.C, the most significant risk for a seller isn’t just the delay, but the potential for open-ended costs.
“The biggest blindspot is failing to include language confirming that the amount of escrow is the cap on the seller’s liability – i.e., if the cost of the action/repair that is the subject matter of the escrow exceeds the amount of escrow, the seller is not liable for the difference. What that leads to is an unknown post-closing obligation from the seller.”
Apart from this liability concern, sellers should also consider these drawbacks:
- Temporary withholding of proceeds: A portion of your funds is locked up at closing, potentially disrupting your financial plans for your next move.
- Lender restrictions: Some loan programs have strict limits on repair expenses or may not permit holdbacks at all, complicating the process.
- Timing risks: If repairs are not completed by the agreed-upon deadline, you may risk losing the withheld funds or facing disputes from the buyer.
- Ongoing responsibility: Even after moving out, you are still responsible for coordinating contractors and ensuring the work passes inspection.
Impact of loan types on escrow holdbacks
The allowance and terms of an escrow holdback are influenced by the buyer’s home loan program, affecting the amount of funds withheld from the seller and the conditions at closing. Loan guidelines can vary, so it is advisable to confirm the specifics with the lender early in the process.
- Conventional loans – more flexibility: Conventional loans usually offer more leeway with escrow holdbacks, as lenders have more discretion on repair types and fewer strict limitations.
- FHA loans – $5,000 cap: Federal Housing Administration loans limit holdbacks to a maximum of $5,000. If repair costs exceed this amount, an FHA holdback may not be feasible.
- VA loans – larger cushion required: VA loans typically mandate an escrow holdback of 150% of the estimated repair cost, temporarily withholding a larger portion of the seller’s proceeds.
>> Read: Different Mortgage Loan Options
Guidance for sellers navigating an escrow holdback
If you are facing an escrow holdback, here are some tips to handle it smoothly:
- Obtain multiple repair estimates: Get detailed estimates from several contractors to ensure the escrow amount is accurate.
- Document everything: Make sure the addendum clearly outlines the scope, timeline, and inspection requirements for releasing funds.
- Verify lender approval early: Confirm that the buyer’s loan program allows for a holdback before reaching the closing stage.
- Stay engaged post-closing: Even after moving out, monitor the quality of repairs and facilitate the final inspection to trigger your payout.
Preventing delays is crucial
Issues often arise during the paperwork stage. Bryan S. Malickson, Esquire, Sales Manager at Mid-Atlantic Settlement Services, points out that a vague agreement is the main reason funds get stuck.
“The most common reason escrow holdback funds get ‘stuck’ or delayed is due to the lack of a clear Escrow Agreement outlining the specific terms for fund disbursement. A clear, specific Escrow Agreement that details the parties’ intentions and the conditions for fund disbursement, including the amount and recipient, greatly increases the likelihood of a smooth disbursement without any issues.”
Frequently Asked Questions: Escrow Holdback
1. Who covers the cost of an escrow holdback?
Typically, the seller covers the escrow holdback expenses from their sale proceeds at closing to address repairs or necessary work. However, arrangements may vary based on agreements between the buyer, seller, and lender.
2. How long does an escrow holdback last?
Lenders usually require repairs to be completed within 30-180 days of closing, though certain projects (e.g., weather-related, extensive repairs) may be granted extensions.
3. What happens if repair costs exceed the estimate?
Escrow accounts typically include a buffer to account for unexpected expenses. If costs still surpass this buffer, the seller is generally responsible for covering the excess amount.
4. Can leftover escrow funds be returned to the seller?
Yes. If repairs are completed under budget and meet the lender’s requirements, any unused funds are returned to the seller once the escrow account is closed.
5. Are escrow holdbacks mandatory?
While not obligatory in every real estate transaction, lenders may mandate an escrow holdback as a financing condition. If so, both the buyer and seller must agree to it for the sale to proceed, making it a necessary condition of the transaction.