What is Escrow in a Real Estate Transaction

By
Real Estate Agent with RE/MAX Executive Realty 91362

Escrow is an important part of the home buying process. Despite this, many buyers and sellers might not understand how does escrow work and how vital it is.

When you are involved in either buying or selling a home, you need someone to hold onto documents and funds during the transaction. This should ensure the paperwork and money are released to the right people at the right time.

A third party is needed to deal with these things to ensure it is fair to both the buyer and the seller. This might be a title company, a law firm, or a specialist escrow company.

Whoever the escrow provider is, they will make sure the terms of the purchase contract are followed before the documents and funds are released.

Let's take a look at what is escrow and how it applies during the real estate process.

What is an Escrow?

When you’ve found your perfect home, you will sign a purchase contract and pay an earnest money deposit. This deposit shows the seller that you are serious about buying the home.

To make sure your deposit is protected, this money is held in an escrow account. This is managed by a third party that is trusted to act independently.

The earnest money deposit protects the seller and allows them to take the home off the market. Should the buyer decide to back out of the purchase, without good reason, the seller may be able to keep this earnest money.

On the other hand, if the seller doesn't follow the terms of the purchase contract, the seller can get their earnest money deposit back.

The escrow provider will be responsible for deciding when the seller has not met the required contract conditions, freeing the buyer from the contract and returning their earnest money to them.

When a real estate company holds escrow funds and there is a dispute between the parties, the deposit cannot be released until there is a resolution.

Sometimes the parties need to go to the court of jurisdiction where a judge will decide who the escrow should belong to.

How Escrow Works

As well as handling the earnest money deposit, escrow accounts can also be used for down payments, closing costs, insurance fees, and anything else involved in the transaction.

The escrow provider is responsible for correctly distributing funds as per the contract and agreements. This might mean payments to real estate agents, insurance fees, title fees, and HOA fees. They can also distribute funds from the mortgage and deal with some of the closing costs outlined in the closing disclosure.

The agent handling escrow will follow the requirements in the contract, as well as the instructions from the mortgage lender. This should ensure that all the money goes where it needs to at the right time.

Escrow is a key part of the home closing process.

Different Types of Escrow Account

Escrow accounts are not only useful in real estate transactions but can also be used in business situations.

During the real estate purchasing process, there are normally two types of escrow accounts used. One of these accounts is used to handle the transaction during the buying process, and the other is known as a mortgage escrow account.

Mortgage escrow accounts

Once you have closed on the home, a mortgage escrow account is used to pay for property taxes and homeowners insurance. This is paid monthly to ensure the money is available when these expensive bills become due.

If you are financing most of the home’s value, you can expect to need a mortgage escrow account. The lender requires this to ensure that these important bills are paid on time, but it also makes budgeting easier.

Other Types of Escrow Accounts

There are also some other uses for escrow that are not related to home buying transactions, these include:

  • Renters escrow; an account to pay your rent into ensuring the landlord makes agreed repairs.
  • Stocks; escrow accounts can be used to hold stocks for many different reasons.
  • Shopping; in some situations, escrow accounts can be used to protect buyers and sellers when buying things online.

Escrow Costs

The fees you can be expected to pay for escrow will be in your loan estimates when you begin the buying process, as well as in the closing disclosure.

Costs for escrow can vary depending on the company used and where you are located. Normally, you can expect this to cost between 1 and 2 percent of the purchase price. However, this service is beneficial to both the buyer and the seller, so the costs are split.

The Advantages of Using Escrow Accounts

Using a third party offers some extra security to buyers and sellers. It makes sure that the terms of the contract are met before the money is transferred to the seller.

Escrow accounts also make sure that money is returned to the rightful owner should the deal fall apart. This insurance protects the buyer and seller, as well as a lender when the sale doesn't get to closing.

With a mortgage escrow account, you'll know that there will be the money to pay taxes and insurance on the home. It also makes sure that buyers have predictable monthly payments, without the need to suddenly find a large amount of money to pay taxes and insurance.

FAQs on Escrow

Let's look at some regularly asked questions:

What is escrow in the home buying process?

An escrow account holds money for the earnest deposit, down payment, closing costs, and mortgage funds. The escrow provider will ensure when closing on the home that this money will be correctly distributed, and this should reduce the stress on the home buyer.

How long does escrow last?

When buying or selling a home in escrow, the fees are one-off costs that are added to closing costs. When you are dealing with a mortgage escrow account, you can expect it to last for the length of the mortgage.

Do you really need to have an escrow account?

Escrow accounts offer a lot of security for buyers and sellers. Offering protection for both sides of the deal and ensuring contract commitments are met.

With mortgage escrow accounts, buyers have an easier time budgeting for these expensive annual payments. This ensures that payments aren't missed, which could lead to foreclosure.

Closing Thoughts

Buying a home is normally the greatest expense people ever make, and escrow offers some protection throughout the process. It is a straightforward idea that also protects the seller during the transaction, and is essential during the process.

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Bill Gassett is a thirty-two year veteran to the real estate industry. He enjoys providing helpful information to buyers, sellers and fellow real estate agents to make sound decisions. His work has been featured on RIS Media, National Association of Realtors, Inman News, Placester, RESAAS, Credit Sesame and others.

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