Want to buy a fixer-upper but don't have the cash on hand for the repairs? Fortunately, buyers have the option of obtaining a special FHA loan that allows them to borrow enough money to buy the property as well as additional funds to make the repairs necessary for the FHA to insure the mortgage.
Repair money is held in an escrow account after the loan closing until the work is done. If you're buying a home from HUD, the listing for the property will specify whether it qualifies for the repair escrow or whether it needs too much work: HUD's repair escrow is meant for homes that need minor repairs that won't cost more than $10,000.
The Department of Housing and Urban Development may end up owning certain properties after foreclosure, which HUD can then sell on the market. When you buy a fixer-upper from HUD, you may qualify for a special loan from the FHA that allows you to borrow enough money to both buy the property and repair it. The HUD repair escrow is an escrow account where the funds for repairs are held until the work is completed.
Funding a HUD Repair Escrow
Funding for a HUD escrow comes out of the buyer's pocket and is rolled into the FHA mortgage. The total amount you can borrow for repairs is limited to 150 percent of the cost estimate for the repairs, including labor, materials and permits, unless the home is owned by HUD, which caps it at 110 percent. For example, if you get an estimate that replacing the bathtub will cost $1,500, you can borrow up to $2,250 (150 percent of the estimate), unless it's a HUD home, in which case you're capped at $1,650 (110 percent of $1,500).
Once the actual work is done and paid for from the escrow account, the lender subtracts any leftover escrow money from the loan balance. The buyer is responsible for costs that overrun the escrow total.
What Can You Do with a HUD Escrow for Repairs?
When you buy a HUD home, the listing for the home will indicate that an inspection has been performed and that the property either 1) qualifies for an FHA loan as-is; 2) will qualify for an FHA loan once less than $10,000 in repairs are made (which means you can use the repair escrow); or 3) the property needs more than $10,000 in repairs and doesn't qualify for the repair escrow option.
The repair escrow is only for noncritical repairs. A buyer can't use a repair escrow for major fixes, including roof work, foundation repair, structural defect corrections, or problems that make the home inhabitable, such as no plumbing or electrical systems. If the property needs more work than the $10,000 minimum, you might need to move to an FHA 203(k) loan, which allows you to borrow up to $35,000 for repairs but doesn't include an escrow.
Disbursement of Escrow Funds
The exact process for escrow disbursement varies by lender. Generally, the buyer must have all work done within 90 days of closing the loan. HUD may allow a longer period, but the lender has the option of setting the deadline. Once the work is completed, the buyer contacts the lender to arrange an inspection. The buyer submits receipts and invoices to the lender for payment or reimbursement, depending on the arrangement with the providing contractor, if the work passes inspection. A buyer who can't find a contractor willing to do the work without full payment up-front may have to pay for the work and get the money back from the lender.
Who Can Perform the Work?
Some lenders allow the home buyer to do the repair work, but others require the use of FHA-approved contractors. In either case, the work must pass the bank inspection for the borrower to get money from the repair escrow. If the work doesn't get done or pass inspection by the lender's final deadline, the lender subtracts the escrow money from the loan balance.
- BananaStock/BananaStock/Getty Images