I was told by a lender that FHA will not allow escrows for point of sale inspections which itemizes issues that need to be corrected prior to the closing or the buyer can be responsible if buyers sign escrow agreement.

Most if not all bank owned properties state that the buyer will be responsible for all inspection items.

I know that FHA has a "203" program, but was told it was for restoration (add value to property) and not to correct or fix issues.

That is a very limited scope of interpretation as that is not how FHA 203K has worked here in execution. The basis is sound on feasibility because not all repairs will contribute to value and thus it may be localized to a specific property, its repair issues and if that market has value declines. If the numbers do not crank out then there is nothing to do but move on to the next property.

Correcting and fixing issues does add value to the property. The purpose behind it is to bring derelict properties back into the rental market.

I did one and my inspector found numerous items that needed to be fixed and we fixed them with 203k money.

Do some more research.

Although it is rare for it to be allowable the statement is false. The FHA Appraisal is what they use to determine what items need repaired prior to closing. If there are items in the inspection that cannot be completed prior to closing due to seasonal limitations such as a roof replacement, exterior painting, and items similar in nature that cannot be performed in the winter then they will allow a repair escrow on the standard 203b program.

Unfortunately this is not the leniency you were probably seeking.

These guys have the 203k side down. I think that it depends on the market. Replacement value exceeds market value in many area's in the US. Even on new construction. So, the advice I would give is to make sure the cost of improvements make sense when added to the purchase price and compared to the market value.

Some minor repairs obviously do not add as much value as they used too. Replacing working items is a perfect example.

Heck some lenders allow you to use 203k to rip out everything but 1 wall of the foundation and totally re-built the home.

Let's try an example. Have a clean bank owned property and the FHA appraisal comes out smelling like a rose. The required Point of Sale city inspection has 5 items that need to be corrected. The estimated cost for these five items is $250. The buyer is willing to pay for these, but would not want to do so until after close. That is ok with the city as long as the buyer escrows 1.5 times estimate. Total of $500. Will FHA (not the 203 program) allow this escrow?

Correct me if I am wrong but I believe that the 203 would not be approved or make sense for minor fixes.

You are right. The 203k carries a 5000 minimum with most of the lenders in the secondary loan market.

If the appraisal notes no repairs needed then the lender should let it close and the buyer can make the repairs after closing.

But will FHA allow the buyer to escrow money as required by the municipality?

Only if the repairs are noted as needing done in the Appraisal.

So in your case no.