Selling Guide

Published August 29, 2017

B5-3.2-04: HomeStyle Renovation Mortgages: Costs and Escrow Accounts (04/01/2009)

This topic contains information on HomeStyle Renovation costs and escrow accounts, including:

Costs and Escrow Accounts

The costs of the renovations will be based on the plans and specifications for the work and on the contractor’s bids for all of the work requested by the borrower. The renovation costs may include a contingency reserve, renovation-related costs, and an escrow for mortgage payments that come due during the renovation period, if the borrower is unable to occupy the property during the renovation.

Contingency Reserve

A contingency reserve equal to 10% of the total costs of the repairs and renovation work must be established and funded for a mortgage that is secured by a two- to four-unit property to cover required unforeseen repairs or deficiencies that are discovered during the renovation. The lender also may establish this contingency reserve for a mortgage secured by a one-unit property.

The contingency reserve may be considered as part of the total renovation costs or the borrower may fund it separately. The contingency reserve may be released only if required, necessary, and unforeseen repairs or deficiencies are discovered during the renovation. Unused contingency funds, unless they were received directly from the borrower, must be used to reduce the outstanding balance of the renovation mortgage after all of the renovation work has been completed and the certification of completion has been obtained.

However, a borrower may use the remaining contingency reserve funds for making improvements or repairs that are permanently affixed to the real property and add value to the property, not to purchase personal property, if the lender:

  • warrants that the work scheduled and described in the plans and specifications was completed and the contingency reserve funds have already been reduced by any cost overruns; and

  • ensures that the contingency reserve funds that are to be used for additional improvements or repairs are actually used to improve the real property, are documented with paid receipts from the borrower’s own funds, and inspections of the additional work or installations are completed by the appraiser who prepared the “as completed” value appraisal report.

Mortgage Payment Escrow Accounts

An escrow for mortgage payments (PITI) that will become due during the renovation period generally may be included as part of the total renovation costs for a principal residence property if the property cannot be occupied during the renovation period.

To make PITI payments while the home is unable to be occupied during rehabilitation, the lender must set up a PITI escrow account, at the loan level, if the borrower chooses to do so.

This mortgage payment escrow must represent only those payments that come due during the period in which the property cannot be occupied.

The maximum amount that may be escrowed is six full payments of principal, interest, taxes, and insurance.

Renovation Escrow Account

At closing, the lender must deposit all of the renovation costs, including the contingency reserve and, if applicable, any escrowed mortgage payments or funds that the borrower provides from his or her own funds, into an interest-bearing renovation escrow account for the benefit of the borrower.

All interest earned on this account, less any administrative expenses involved in maintaining the account, must be paid or credited to the borrower.

The renovation escrow account must be a custodial account that is established in a depository institution insured by the FDIC or the National Credit Union Administration and that otherwise satisfies Fannie Mae’s criteria for custodial accounts.

A lender may commingle the renovation escrow accounts for different borrowers in the same custodial account.

The funds in the renovation escrow account must be used to complete the repair and renovation work and, if applicable, to make any mortgage payments that come due during the renovation period.

The lender, or its agent, is responsible for administering this account and ensuring that the repairs and renovation are completed in a timely manner and in accordance with the plans and specifications and the contractor’s estimated bids.

The lender should release funds from this account to the contractor and the borrower only when any given renovation work has been completed, and then only in accordance with the agreed-upon schedule and after receipt of a specific request.

Should there be an increase in costs during the renovation period, the borrower, or the lender, must fund the amount of the increase; Fannie Mae will not increase the mortgage amount to offset any increase in costs. The lender must ensure that the additional funds are obtained in a manner that will not affect the priority of Fannie Mae’s lien.

Once the renovation has been completed, all funds remaining in the renovation escrow account, including any mortgage payment reserves, may be used to either reduce the unpaid principal balance of the mortgage, unless they represent funds deposited separately by the borrower, or to make additional improvements or repairs to the property that are permanently affixed and add value to the property.