B5-3.2-04, HomeStyle Renovation Mortgages: Costs and Escrow Accounts (08/07/2019)

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.

The contingency reserve should cover all renovation-related costs including labor, materials, fees, permits, plans and specifications, inspection costs, and other expenses related to the renovation.

A contingency reserve is not required for a mortgage secured by a one-unit property, however the lender may choose to establish one. 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 may increase the contingency reserve to 15% if it determines the higher reserve is appropriate given the scope and scale of the renovation.

The contingency reserve may be considered as part of the total renovation costs or the borrower may fund it separately. It 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 loan 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 additional improvements or repairs to the 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,

    the improvements or repairs 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.

At the borrower’s request, up to six mortgage payments (PITIA) that will become due during the renovation period 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. The lender, servicer, or its agent must hold the funds in a renovation escrow account, and only apply them to payments that come due during the period in which the property cannot be occupied.

Note: The lender may set up a separate escrow account for the mortgage payments in lieu of including the funds in the renovation escrow account.

The renovation costs (less any draws made at closing), the contingency reserve, mortgage payments (if applicable), and monies that the borrower provides from their own funds, must be deposited into an escrow account for the benefit of the borrower. The renovation escrow account must meet the requirements shown in the following table at the time of delivery to Fannie Mae.

Note: The lender may fund up to 50% of the planned materials cost at closing with an initial materials draw. A portion of this draw may be used to pay for permits, architect fees, and design or planning expenses that were incurred during the initial part of the project.The lender must obtain periodic inspections to confirm the work is being completed as planned prior to the issuance of additional escrow draws.

Should there be an increase in costs during the renovation period, the borrower, or the lender, must fund the amount of the increase. The lender may not increase the loan 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.