Repair Escrow: How HUD Funds Deferred Repairs after Closing

Key points

• Critical life safety repairs cannot be escrowed; they must be completed before closing.
• Non-critical repairs can be deferred to the escrow and generally must be finished within 12 months of closing.
• The 20 percent cushion above repair cost is non-mortgageable, so it comes from the borrower's funds.
• Credible bids are required for work items over $35,000.
• When repairs are deferred, half of any cash out is held until the repairs are done and HUD approves release.

What goes into the escrow

The CNA sorts immediate needs into critical and non-critical repairs. Critical life safety repairs must be completed before endorsement, and a HUD representative's site visit and report confirms them before closing. Critical accessibility repairs must be done as soon as possible, but HUD can approve deferral when earlier completion is not possible, and those deferred items go into the escrow along with non-critical work. Non-critical repairs include work needed now or within the first two years, and upgrades intended to improve marketability or efficiency.

Before approving deferral, HUD requires work write-ups detailed enough for inspection, a schedule for completion, credible bids on items over $35,000, a schedule of values for progress payments, and a list of any units or facilities whose occupancy or income will be interrupted.

How the escrow is sized

The MAP Guide sets the escrow at 120 percent of the cost of deferred repairs, established at closing. The 20 percent above the repair cost is an assurance of completion. It is non-mortgageable, meaning the HUD loan cannot fund it, and it may be reduced to 10 percent for affordable and Section 223(a)(7) transactions.

Two other rules tie the escrow to proceeds. If deferred repairs will interrupt occupancy or income, HUD requires an additional deposit to an operating deficit account in an amount HUD sets. And on a cash-out refinance with deferred repairs, 50 percent of the cash out (after mortgageable transaction costs and assurance of completion) is held in escrow until the repairs are completed and HUD approves release of the remaining repair escrow.

How draws work

Repairs must begin immediately after closing and, with limited exceptions, finish within 12 months. Funds are released for completed hard costs. Where a project architect or general contractor is involved, the contractor or architect prepares a request for approval of advance of repair escrow funds with supporting documentation, the architect and HUD inspector (when applicable) inspect and sign it, and the owner signs and forwards it to the lender. Partial payment for a work item is allowed only when its progress can be distinctly inspected. Deposits or down payments on materials generally should not be funded from the escrow.

• Keep the schedule of values line items matched to the CNA and bids, since the HUD inspector recommends payments against it.
• Process change orders through HUD's procedures rather than informally with the contractor.
• Submit the supplemental cost certification for deferred repairs within 15 days after completion.
• If actual costs come in below estimates and the maximum insurable mortgage drops, the excess goes to a loan prepayment, the replacement reserve, or a payment to the lender.

Bridge-period work versus escrowed work

Owners exiting a bridge loan often have a choice: finish the renovation during the bridge term, or close the HUD loan sooner and complete the remaining work from a repair escrow. Finishing first reduces the escrow, the non-mortgageable cushion and the cash-out holdback, and can raise value and NOI. Escrowing lets the owner exit expensive bridge debt earlier. HUD's environmental rules matter for the sequencing: once the HUD application is submitted, repairs exceeding routine maintenance generally cannot proceed until the environmental review is complete, so work should either be finished before submission or planned into the HUD scope.

Where to go next

For how repairs are scoped in Bravo's 223(f) loans, see HUD 223(f) loans.

For completing renovations on a bridge loan before a HUD refinance, see bridge-to-HUD financing.

Related guides: HUD Reserves and Repair Escrows: What Gets Funded at Closing; Value-add Renovation with a Bridge Loan, Then HUD 223(f); Third-Party Reports in a Bridge-to-HUD Execution.

Related terms: Capital Needs Assessment (CNA): What It Means in a HUD Loan; Replacement Reserve: How HUD Sizes and Controls It; What Is a HUD Section 223(f) Loan?; Operating Deficit Escrow: Covering Lease-Up Shortfalls.

For portfolio figures by state, metro and program, see the HUD multifamily data hub. Bravo Capital’s record: all 26 HUD firm commitments received since April 2022 have closed, totaling $526.0 million (HUD Closing Scorecard).