Escrows and Replacement Reserves for HUD 221(d)(4) Loans
If you want to apply for a HUD multifamily loan, part of the HUD 221(d)(4) process involves making sure you have enough money saved in escrow-- i.e., in a third-party account, to cover a variety of expenses.
Escrow and Replacement Reserves for FHA Multifamily Construction Loans
If you want to apply for a HUD multifamily loan, part of the HUD 221(d)(4) process involves making sure you have enough money saved in escrow (see below). This is money in a third-party account which has been set aside to cover a variety of expenses. According to HUD guidelines, an owner/developer needs:
What are Replacement Reserves?
Over time, building components and equipment will wear out. Replacement reserves exist to fund the replacement of these things. According to HUD guidelines, an owner/developer needs:
2-4% (typically 4%) of the amount of the loan in working capital reserves
3% of the loan amount as an operating deficit reserve
What is an escrow account for a HUD 221(d)(4) loan?
An escrow account for a HUD 221(d)(4) loan is a third-party account that holds assets (money, funds, securities) on behalf of two other parties until a transaction is completed. HUD 221(d)(4) escrow requirements include specific percentages of the loan amount to be set aside in order to guard against financial risk. This includes required replacement reserves, which can vary by project, but usually amount to 4% of the total loan amount. A 3% operating deficit reserve is also required in order to help pay for unexpected expenses or periods of lower-than-expected occupancy.
To learn more about HUD multifamily construction loans like the HUD 221(d)(4) loan, fill out the form below and a HUD lending expert will get in touch.
What is the purpose of a replacement reserve account for a HUD 221(d)(4) loan?
The purpose of a replacement reserve account for a HUD 221(d)(4) loan is to set aside money to replace building equipment and components which wear out over time. This is designed to pay for general building repairs. According to HUD 221(d)(4) Loan Program, all HUD multifamily loans require replacement reserves, but these requirements vary with different loan types. HUD 221(d)(4) loans require 2-4% (often 4%) of the total loan amount in working capital reserves.
How much money is typically required to be held in an escrow account for a HUD 221(d)(4) loan?
For a HUD 221(d)(4) loan, taxes and insurance are typically escrowed monthly (post-construction). Additionally, a working capital reserve account equal to 4% of the loan amount is required (paid in cash or a Letter of Credit (LOC)), with the unused amount refunded, as per "additional items" below. An operating deficit reserve equal to at least 3% of the loan amount is also required; unused amount later refunded as per "additional items" below.
Annual deposits are also required for replacement reserves equal to the greater of (a) 0.60% of the total cost for new construction or 0.40% of the loan amount for substantial rehabilitation projects; or (b) $250 per unit per year. In certain circumstances, HUD may consider waivers if calculations exceed $500 per door.
What is the difference between an escrow account and a replacement reserve account for a HUD 221(d)(4) loan?
The difference between an escrow account and a replacement reserve account for a HUD 221(d)(4) loan is that an escrow account is used to pay taxes and insurance on a monthly basis after construction is complete, while a replacement reserve account is used to save funds to replace necessary equipment and components over time. According to HUD 221(d)(4) Loan: Escrows, an owner/developer needs 2-4% (typically 4%) of the amount of the loan in working capital reserves and 3% of the loan amount as an operating deficit reserve. If unused, these funds will be refunded at a later date, typically after 6 months of "break-even" operations. In addition, after the project is finished, taxes and insurance will also need to be placed monthly in an escrow account.
What are the requirements for setting up an escrow account for a HUD 221(d)(4) loan?
For a HUD 221(d)(4) loan, the requirements for setting up an escrow account are:
- Replacement reserves are required in accordance with HUD guidelines.
- Taxes and insurance must be escrowed monthly (post-construction).
- A working capital reserve account equal to 4% of the loan amount must be paid in cash or a letter of credit, with any unused amount refunded.
- An operating deficit reserve equal to at least 3% of the loan amount must be set up; the unused amount is later refunded.
How often must the escrow account for a HUD 221(d)(4) loan be replenished?
The escrow account for a HUD 221(d)(4) loan must be replenished monthly (post-construction). Taxes and insurance must be escrowed monthly.
Source: apartment.loans/hud-221-d-4-loans and www.hud.loans/fha-221d4
By having these funds in reserve, building owners can proactively save funds to replace necessary equipment and components.
Both of these, if unused, will be refunded at a later date, typically after 6 months of "break-even" operations(the project's monthly income is meeting or exceeding the project's expenses). In addition, after the project is finished, taxes and insurance will also need to be placed monthly in an escrow account.
What is Escrow?
Merriam-Webster defines escrow as “a deed, a bond, money, or a piece of property held in trust by a third party to be turned over to the grantee only upon fulfillment of a condition.”
In real estate, escrow allows large sums of money to be held until a transaction is finalized. For example, when the sale of a property comes with conditions, funds are held until the conditions are met. Afterwards, the escrow company then transfers the money to the buyer.