Let's say you are in contract to buy a house, and the closing is only two days away. It rains hard the night before your final walk-though (a standard step in the process, probably mentioned in your purchase contract). When your broker and you enter the house the next morning, you see a stream of water running from a drain outside, going under the patio door and through the living room. What's more, the basement carpet is wet and stained.
Now what? You will naturally want figure out what happened and negotiate with the seller to pay for repairs, but don't want to delay the closing, if possible. How exactly should this be handled, with the closing so soon? Here, we'll suggest steps for setting up and monitoring an efficient method for dealing with this situation, using what's called a "repair escrow."
By now, you've probably already had a home inspection done (assuming you included that as a contract contingency) and then removed that contingency. If you haven't yet removed that contingency, however, and if you feel this event reflects a major problem or seller fraud such that you want out of the contract, now's the time to speak up and potentially cancel the contract.
If it's too late to cancel per this contingency, you can nevertheless still negotiate with the seller (most likely through your real estate agents). After all, the expectation is that the sellers will deliver the house in basically the same condition as it was advertised and presented to buyers. Actual fraud could be considered a breach of the contract terms, creating a justification for you to cancel.
But even without fraud, the sellers will need to cooperate in getting the problem examined and establishing the cost of repairs. If possible, get a plumber and/or other pros out to the property right away, to give you a description of the work expected and cost estimates.
However, so near to the closing, it might be difficult to do this. In that case, you can state that the repair escrow agreement (described below) will be amended when the estimates are received, and attach them as an exhibit to the agreement when received. You and the seller can also agree that all of proceeds of the closing will be held in the repair escrow until the estimate becomes available
Once that's done, you can move on to setting up the financial mechanism for the seller to pay for those repairs.
At or prior to the closing, you and the property seller should write out an agreement spelling out all of the repair work to be completed by the seller, the procedure for paying contractors who do the work and refunding the balance back to the seller, and any other terms you have negotiated.
Then, at the closing, you will ask the settlement agent to hold back the seller's proceeds, or a portion of the proceeds, and place the money into an escrow account.
The settlement agent for your closing, be it the title insurance company or a separate escrow company, might be the best choice for "escrowee" (the party to hold the seller's proceeds) and to follow the instructions you and the seller describe in the agreement.
Title and escrow companies are in the business of holding funds and making payments based on instructions listed in escrow agreements. Given that this company is already settling your closing of escrow, it could act as escrowee for this separate arrangement, for a small additional fee.
In states where the closing is done by an attorney, the attorney acting as your settlement agent can be the escrowee. Sometimes, the listing agent will act as escrowee.
The title or escrow company or attorney will give you a form document, called "escrow instructions," which you can use as a starting point for your agreement.
If you have a lender, the escrowee will show the portion of the seller's proceeds going into the repair escrow on the settlement statement, and will notify the lender. The lender must approve of the repair escrow and how it's shown on the closing documents.
In addition to stating the amount of money to be held, and designating the escrowee, the agreement should include a detailed description of the work to be done and a list of the documents the seller will furnish to prove that the work was completed properly and that the contractors have been fully paid. The agreement might also include a description of the warranties you will receive from the contractors, if any, and any other terms to be met before the escrow company can disburse the balance of the sale proceeds to the seller.
Also, the repair escrow should outline the procedure that the escrowee will use to pay the contractors. You can require that they be paid directly from the funds held in the repair escrow rather than allowing the seller to pay them, and seek reimbursement from the repair escrow.
It's particularly important that the escrowee pay contractors directly from the funds in the repair escrow if you live in a state where an unpaid contractor may automatically receive an interest in the property similar to a mortgage called a "mechanic's lien." In these states, the contractor should give the escrowee construction paperwork before receiving payment.
The agreement can include additional provisions to ensure that the repairs are done in a skilled and well-executed manner. You might (and probably should) ask for time in which to inspect the work before payment is made, and require remediation, or payment of damages, for incomplete or faulty work.
The contractor should give all warranties to you in your name, and not to the seller. Include details about what will happen to the money in the repair escrow if the work drags on, without being completed in a timely fashion. You might want to include a schedule of increasing penalties to the seller for such a situation, and state that you will have the right to use the funds in the escrow account to complete the repairs yourself..
If the full amount of the sales proceeds far exceeds the expected cost of the repairs, you can agree to some smaller portion of the proceeds. Don't be afraid to ask for an amount that exceeds the expected repair costs before you know the extent of the problem. It's possible, even likely, that the cause of the leak or other defect involves more work than everyone might originally believe to be the case.
For example, a leak might be caused by a broken drain, broken drainage tiles underneath the property, incorrect grading, roots growing in the drain, or problems at the buffalo box that connects the property to the municipal water line or sewer.
If you receive the estimates, and they show that the work will be less costly than the amount held, you can disburse the excess proceeds to the seller and hold an amount closer to the amount shown in the estimate. However, even after you receive estimates, you should continue to hold an amount of money substantially greater than the estimate amounts, as a cushion for unexpected problems in completing the repairs.