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Home repair escrows are special accounts that hold funds that can be used for repairing houses. They can be placed for different reasons, but have a similar effect. Putting money into escrow for a repair can allow your lender to make a loan on the property’s repaired value instead of its as-is value, allowing you to effectively put less down.
HUD Home Repair Escrows
When you buy a house that the Department of Housing and Urban Development has repossessed, the home is usually sold on an as-is basis. However, HUD also controls the Federal Housing Administration program that insures the mortgage that you might use to buy the house. It will sometimes put up to $5,000 into escrow to pay for repairs for buyers who want to use FHA loans. In this case, the money must be used between 90 and 360 days of when you close on your FHA mortgage.
FHA 203(k) Loans
When you buy a house outside of a HUD repo that needs repair or renovation, you could choose to take out a FHA 203(k) loan. These loans are designed to help you rehabilitate homes by letting you borrow up to 110 percent of the estimated value of the house after it is repaired. The extra money between the home’s purchase price and the amount of the loan is placed in a special rehabilitation reserve and gets released to the contractor as he completes work on the house.
When sellers need to repair a property, an escrow account solves a few problems. If the repairs can’t be completed before the closing date, having them escrow the funds lets you get it done on a reasonable schedule without delaying the transfer of the home. It can also help you obtain more money from the seller to cover the repairs, since the seller can specify that any funds that aren’t used on the repairs be returned to him. Alternately, if the funds come from the lender, they get applied back to your mortgage’s balance.
Escrow vs. Price Reduction
If your lender will allow you to have your seller put funds into escrow, you will spend less money out of pocket than with a price reduction, since your loan amount doesn’t go down. For example, if you intended to buy a $200,000 home with 20 percent down, you’d have a $160,000 mortgage after putting in $40,000 of your own money. If the seller reduced the price to $185,000 to cover a major repair, your loan would go down to $148,000 (80 percent of the $185,000) and your down payment would go down to $37,000, but you’d still need to take the $15,000 out of pocket for the repair for a total cost of $52,000. An escrow account keeps the loan amount the same.