“Escrow” is a phrase often used in real estate transactions; however, often, neither the buyers nor sellers fully comprehend what it is and how it works. Escrow is required in most homes, and mortgage lenders usually require that borrowers maintain escrow accounts to pay tax liabilities for the property and homeowner’s insurance. This
What Is Escrow?
“Escrow is an agreement, a deed, or any other type of document that is kept by an outside party that is taken into effect only after a specific condition has been satisfied,” explains Eddie Martini, the strategic real estate investment expert with Real Estate Bees in the Greater Sacramento, California, area.
It allows each party in a real estate agreement to contract with an outside party, typically an escrow firm or an escrow agent mortgage servicer, to detain property or money until specific requirements are fulfilled temporarily. Martini says that after both parties comply with all conditions of their contract, the funds and property are granted release.
What is the process of escrow work?
Greg Forest, the senior global real estate consultant to Sotheby’s International Realty in Palm Beach, Florida, says that when a sale agreement has been signed, or the contract is completed, the account for escrow can be “opened.”
“The buyer funds the account. The funds remain in the account until any obligations such as home inspections or approvals for financing are completed,” Forest says. “If everything goes according to plan and the sale is completed beyond contingencies, funds are transferred to the seller when the closing is completed, or funds are arranged. If not, they could be given back at buyers’ request.”
Typically, the seller’s agent is required to open an account with an escrow firm for the seller’s benefit after the sale is approved in written form, Martini explains. “Many states let buyers select which company manages the escrow. So in some cases, even if the seller has an escrow in place through a single company, a buyer may choose to have the account opened at the company they choose. It is state-by-state or, in certain cases, counties by counties,” Martini says. “Some counties and states allow titles and escrows to form one entity; however, some need them to be distinct entities.”
Different types of Escrow Accounts
According to Forest, when it comes to real estate, there are two distinct kinds of escrow accounts: one for the purchase process and one used following the purchase of a property or home.
Escrow Account used to buy a Home
After you decide on your agent, search for real estate in the MLS, put in an offer, and have it accepted by the seller, escrow will likely come into play. Escrow keeps the property and any funds associated with the transaction, such as the down amount, closing expenses, and earnest cash, until the conditions of sale are satisfied.
If you are making an offer for an apartment, most buyers will offer earnest money or an “in good faith” deposit to show their intention to purchase. The earnest money safeguards sellers if the buyer withdraws in the event of a transaction not going through. If the purchase is successful, the earnest funds go towards the buyer’s closing costs or the down cost.
To safeguard the buyer and the seller, the money remains in an escrow account until the time of closing. If a seller fails to stick to the terms of the contract in the end, then the earned funds in the escrow account are returned to the buyer. Afterward, the buyer will be exempt from the contract.
Escrow Accounts for Taxes as well as Insurance
Although escrow accounts are used in the buying process to ensure the security of all involved parties during the purchase, Forest claims that an escrow bank account also serves to store the homeowner’s money to pay property taxes and homeowners insurance.
To reduce the possibility of defaulting in the repayment of your loan or acquiring liens against the home, mortgage lenders will want to be sure that you pay your homeowners insurance and tax on your property promptly. The lender will divide the bill into equal installments and include this amount in the monthly mortgage installment. The lender keeps this money to cover expenses on your behalf.
If you’re not required to open an escrow account for your mortgage, you’ll have to cover the bills yourself. They’re typically big bills that homeowners must pay once every two years or once. If you do not pay your taxes on property and/or your local administration could impose fines or penalties or even a tax lien on the property you live in. Then, eventually, the local government could take action to obtain the foreclosure process.
The benefits of having an Escrow Account
Escrow accounts protect each party involved in a real estate deal. Additionally, it helps homeowners pay their tax and insurance charges on time.
“Peace in your mind” is the most important benefit,” Martini says. “Having a neutral third party to keep your essential documents, as well as all the money, lets you know that as long as you take responsibility while the other side completes their part, the final is your plan.
“Without the account for escrow and an independent third party, you’re relying on that person’s ability to remain faithful to their word, and this is a risky presumption to make for the business.”
For homeowners who have an account for escrow, this can reduce the burden of having to come up with large payments to pay for taxes and insurance. “It can also make budgeting easier for homeowners, allowing them to spread out the cost of a large year in smaller installments,” Forest says.
