There are few situations more exciting than closing on your new home.
You and your family eagerly await the moment you can sign the paperwork and take possession of your new residence. In this place, you can finally rest easy and enjoy all the benefits of ownership.
But what do you do when closing is fast approaching, and work on the house remains to be done?
What if you are buying a newly constructed home and the contractor has not completed the landscaping or the seller has not finished the promised repair work on the basement?
What if you are selling the home and find that the work will only be finished after closing? Can you still close?
Yes, you can, and the solution is affectionately known in real estate circles as an escrow holdback or holdback escrow.
An escrow holdback is simple money to assure the seller that the agreed-upon work will be finished later. Monies are held in an escrow account until the obligation has been finalized.
It is like an insurance policy. The key is putting the right amount of money in escrow to motivate the seller to want the funds back.
Over my long career as a real estate agent, there have been many instances where a holdback agreement was put together to ensure the contract was completed as agreed. One of the essential aspects is holding back an amount of money that will motivate the party to get the funds back. Without an adequate holdback the contract may not be honored. This is why attorneys always insist on an amount that will be motivational.
How Does an Escrow Holdback Agreement Work?
There are a surprising number of situations where the closing on a home sale gets pushed back, especially situations involving yet-to-be-completed work on a property.
The buyer is ready and waiting to close the sale on the agreed-upon date, but for some reason, all the promised construction has not been finished.
The answer to this problem is often to request an escrow holdback agreement!
Unless you have bought and sold homes frequently or work as a builder or a real estate agent, you may not be familiar with an escrow holdback.
A deferment agreement allows a portion of the seller’s proceeds to be held in escrow until the work on the home has been completed. Addressing deferred maintenance through a holdback can prevent delays in the closing process.
The money held back provides some security for the lender and the buyer, ensuring that they are compensated if, for some reason, the work is not completed as promised. It is a financial safeguard, ensuring funds are available for necessary repairs or improvements.
Lenders view escrow holdbacks as collateral protection, ensuring the property meets safety and soundness standards. I recommend the escrow agreement clearly outlines the conditions under which the holdback funds will be released.
Convincing a lender to close a house without such a guarantee isn’t easy. They want to get what they paid for, after all. A property appraisal often identifies issues that may necessitate an escrow repair holdback.
Situations Requiring An Escrow Holdback
There are numerous reasons why you might request an escrow holdback. Some of the most common reasons for a holdback include the following:
- Approval of newly installed systems – most notably a septic system, etc.
- Repair work that has yet to be completed.
- Renovations that have yet to be completed.
- Title issues.
- Missing mortgage discharges.
- Cleanups that have yet to be completed.
- Discharging conservation issues.
- Other seller obligations are required for closing.
Not too long ago, while selling a home in Grafton, Massachusetts, it was discovered that several discharges for an old conservation recording were missing.
It was a reasonably easy fix, but completing the discharges would take about a week. The parties agreed to hold back a couple thousand dollars to ensure the discharges were completed and the closing happened as scheduled.
It is just one example of what can happen in a real estate transaction. The holdback becomes the solution to keeping the agreed-upon closing date. In essence, the holdback agreement prevents the closing from being delayed.
Understanding the Legal and Regulatory Landscape
Understanding the legal and regulatory framework of escrow holdbacks is crucial for buyers and sellers in the real estate market. For instance, the FHA escrow hold-back program lets FHA borrowers finance repair costs, ensuring that required repairs are completed post-closing.
This program stipulates that no more than $5,000 worth of repairs may be requested. The completion deadline must also be within 30 days of loan closing. Understanding these guidelines is essential for parties involved in FHA transactions to leverage escrow holdbacks effectively.
I always recommend my clients investigate holdback rules before proceeding.
Talk To Your Lender About Holdback Escrow
Like most home buyers, you are probably getting assistance from a lender to purchase your new home.
Lenders are, naturally, very picky about the situations where they will loan money.
The fact that you are already cleared for a mortgage means you have already jumped through numerous hoops to get your financing.
If a holdback is necessary, you must prepare to talk to your lender about it. You will need lender approval to close on the house.
The lender’s underwriter will review the holdback terms to ensure compliance with lending guidelines.
It’s essential to understand that not all lenders will allow a holdback. Since it’s possible your lender won’t accept a holdback escrow, it is vital to discuss it immediately when you know one will be needed!
Expect Inspections to Be Required
Your lender will likely set some conditions to allow the holdback, typically an inspection of the new work that has yet to be completed.
When the work is finally done, the lender will probably want to have it inspected to verify that it is up to standard.
If it is not up to standard, the lender may not release the escrow funds to the seller.
Remember that most lenders will require the escrow amount to exceed the work’s value. Traditionally, lenders ask for at least 1.5 times the cost of repairs/renovations yet to be completed.
You may run into a situation where your lender will not allow you to have an escrow holdback. If this is the circumstances you find yourself in, you cannot do much besides push back the closing date.
When selling your home, and some work is not completed, you can always point out that you want to ensure that the job is done right and that the house comes in the best possible condition to the buyer.
If you are the buyer, you must decide if it is worth waiting or if you should try to buy another home.
Some Mortgage Programs Have Specific Requirements
If you are getting an FHA loan or VA mortgage, it is essential to understand their holdback guidelines.
The Federal Housing Administration (FHA) loan program, administered by the Department of Housing and Urban Development (HUD), enables home buyers to access funding. There are specific requirements regarding FHA escrow holdback procedures; no more than $5,000 worth of repairs may be requested.
The Department of Veterans Affairs guarantees VA loans, and the guidelines for a VA loan escrow holdback are similar to those of an FHA loan. However, borrowers must front 150% of the cost of repairs to obtain a VA loan.
Fannie Mae will allow 10 percent of the appraised value, and Freddie Mac will allow 15 percent as a maximum holdback.
There are also timeline requirements for completing the necessary work. With conventional and FHA loans, the work must be completed 180 days from closing.
The VA requires work to be completed no more than 90-120 days from closing.
Common Examples of HoldBack Escrow Agreements
Look at potential ways to see holdback escrow agreements used in real estate transactions.
Septic System
Completing a septic system is one of the more common holdbacks in real estate sales. In many states, including Massachusetts, a septic system must be inspected before closing.
This is what’s known as a Title V septic inspection. Sometimes, a seller will run into a miserable situation of failing the inspection.
Septic systems are costly to replace. The cost of a septic system can easily be tens of thousands of dollars depending on several factors, including soil conditions, water table, etc.
When sellers discover their system has failed, they can do only two things: replace it before closing or put money in escrow.
Buyers and sellers commonly find that holdback escrow agreements help close as planned.
Due to the timing of the meeting closing dates, it is often not possible to get a septic system installed before what’s been agreed upon. This is where an escrow agreement can be drawn up.
In my experience, mortgage lenders will always require a seller to hold back a minimum of 1.5 times the actual cost of replacement. So, if the estimate is $20,000 for a new system, most lenders will require $30,000 to be held in escrow until the work is completed. This is to ensure that any overruns are entirely covered.
So, if you’re buying a house with a septic tank, ensure you know your state’s rules.
New Construction
New construction is another common area of real estate sales where you will find money held back at closing.
There are many occasions when a builder agrees to a closing date, and things come up during the home’s construction that delay the progress.
You may be selling and buying a home at the same time and have no place to go other than an expensive hotel.
As long as the builder can get an occupancy permit, you may still be able to move into the house without it being finished.
There could be work; however, that needs to be done. You would love to trust your builder when they say it will get done, but your attorney is whispering in your ear, saying, “No way!”
This is another popular place where escrow monies can be held back from the sale.
Sometimes, during a final inspection of new construction, the real estate appraiser flags work that has not been completed.
The inspection could trigger the need for a holdback agreement.
Building Holdback Escrow Examples
Some common examples of holdbacks in new construction include:
Landscaping
- Landscaping—Completing landscaping is a typical example, especially when the home is in a cold climate and is being built in winter. There are times when a lawn and landscaping just can’t be completed. Landscaping could include the lawn, shrubbery, patios, stonewalls, and a sprinkler system.
Driveway Completion
- Driveways – On many occasions, a builder will provide a paved driveway that includes two coats of asphalt. Many builders will put on the first coat and want it to cure before putting on the final top coat.
Conservation Completion
- Conservation issues—If the new home was built close to wetlands, the builder might occasionally not get what is called a “certificate of compliance” before closing. It may be that the conservation board has not yet met and given the site its blessing. There could also be a “blanket order of conditions” on an entire subdivision where a builder needs to get individual lot releases.
Punch list Item
- Punch list items—If you are building a home with more than a few small items left to be done, a holdback may be necessary. This is especially important if the sum of what must be done adds up to a decent amount of money.
One essential factor in determining whether you need or want a holdback is the builder’s reputation for returning and completing his work.
Some do exactly as they say, and others need something held over them to get things done. I suggest speaking to a couple of the builder’s past customers and getting their experiences about how well you can trust the builder’s word.
Builders Refusing Holdbacks
<p>While most home-building companies are reputable businesses, some may attempt to deny you an escrow holdback. It would be best if you were always suspicious of any builder that would outright reject your request.
Any experienced real estate agent and any honest home builder will tell you that sometimes, new homes are not completed on time.
There are too many variables to allow for a factory-like efficiency in meeting deadlines.
A builder that insists the work will be completed after you close is not a builder you should buy from unless you know they have a sterling reputation and have no issues with other clients in such matters.
Avoid Closing Without An Escrow Holdback
<p>If you are buying a home still being worked on, do your best to look at the situation objectively. Closing on the house without a holdback is a risky proposition.
You never know if a builder or seller will do the work if you have no guarantees. The holdback is your leverage, ensuring the home is completed to the agreed-upon specifications. Without such a guarantee, there is always a risk that the work will never be completed.
No matter what any builder or home seller tells you, closing without a holdback is not something you should want to do. If you are leaning that way, make sure you can trust the builder to come back as promised.
Final Thoughts
Holdback escrow agreements are a standard part of the real estate landscape. When the situation arises, it is crucial to work with a real estate attorney to approve the language so you are protected.
Both buyers and sellers should sign an equitable arrangement that is fair to both parties. Drafting holdback language is very common for attorneys.
About the Author: Bill Gassett, a nationally recognized leader in his field, provided the above real estate information on what an escrow holdback is</span>. Bill has expertise in mortgages, financing, moving, home improvement, and general real estate.
Learn more about Bill Gassett and the publications in which he has been featured. Bill can be reached via email at billgassett@remaxexec.com or by phone at 508-625-0191. For the past 38+ years, Bill has helped people move in and out of Metrowest towns.
Are you thinking of selling your home? I am passionate about real estate and love sharing my marketing expertise!
I service Real Estate Sales in the following Metrowest MA towns: Ashland, Bellingham, Douglas, Framingham, Franklin, Grafton, Holliston, Hopkinton, Hopedale, Medway, Mendon, Milford, Millbury, Millville, Natick, Northborough, Northbridge, Shrewsbury, Southborough, Sutton, Wayland, Westborough, Whitinsville, Worcester, Upton, and Uxbridge Massachusetts.
