What is escrow?
If you’re considering buying a home, congrats! Knowing where to start and understanding the journey can be daunting. But don’t worry, we’re here to help. In this article, we’ll tell you about escrow - an important and somewhat confusing part of the home buying process.
Escrow comes into play during the due diligence period. This is the time after you have your offer accepted and before closing. It's essential to make the most of this time and do thorough research in order to make the most informed decision about whether you want to go ahead with the purchase.
This is also when you (the buyer) have the chance to renegotiate or back out of the transaction if you are unhappy with the terms. Therefore, it is quite important to be familiar with escrow and how it works.
This article will break down the escrow process, helping you understand what it is, who manages escrow, why it is important, and how much it costs. Let’s take a look.
Understanding escrow in real estate
Escrow is a legal arrangement where a neutral third party holds onto assets or funds during a transaction until specific conditions are met. When both parties (buyer and seller) have completed their obligations, the third party will release the funds to the appropriate person.
Earnest Money
Earnest money is provided by buyers to show the sellers that they are serious about buying the property. The buyer will put their funds in escrow if their offer gets accepted.
The escrow account protects the buyer's deposit. For example, if you find an issue during the inspection and want to back out of the deal, you might have a hard time getting your funds back from the seller. With your funds in escrow, you’ll be able to get your money back with ease.
It’s also worth noting that the seller has protection as well. If the buyer backs out of the sale without a qualifying reason or contingency, that money is given to the seller.
Who is in charge of escrow accounts?
Escrow accounts are usually managed by an escrow company, agent, or mortgage servicer. Typically, the seller’s agent is responsible (to ensure property taxes, homeowners’ insurance fees, and other expenses are paid on time).
Since an escrow benefits both the buyer and the seller, the fee for managing an escrow account is usually split evenly between both parties.
What are escrow companies?
Escrow companies, also called title companies, are neutral third parties that work to protect the interests of the parties directly involved in a real estate transaction.
What does an escrow account cover?
Escrow accounts pay your homeowner insurance, property taxes, and mortgage on your behalf. You’ll typically pay these fees alongside your mortgage each month in just one payment, making it easier to manage your expenses. However, escrow accounts won’t cover all your home-related expenses, like your energy, internet, or HOA bills.
Escrow accounts also cover the costs of your home inspections and appraisals. Home inspections are not mandatory when purchasing a home, but they are highly recommended. Inspection reports tell you about damage or dangers in the home, so you can back out of the purchase or renegotiate your deal with the seller.
Lenders conduct their own property appraisals before they agree to lend on the home. Usually, the buyer is responsible for home inspection and appraisal fees, which can be billed to escrow.
Why is opening an escrow account important?
Escrow accounts are beneficial for both buyers and sellers. For buyers, one of the main reasons to open an escrow account is for financial protection throughout the real estate transaction.
As a homeowner, opening an escrow account can ensure that your taxes and insurance bills are paid on time. Since escrows are maintained throughout the mortgage term, an escrow account will hold funds for taxes and homeowners' insurance, so you don't have to worry about keeping track of these expenses.
For sellers, an escrow means that the transaction is legal and extensively documented by the third party. If the buyer backs out of the sale for unqualified reasons, they ensure you still receive the earnest money the buyer promised.
How much does escrow cost?
The average cost of escrow fees is typically 1% to 2% of your home's purchasing price; however, it may vary depending on the company that manages your account.
Closing with escrow
When closing, the buyer will be required to put funds to cover their downpayment and closing costs in the escrow account (minus any earnest money they have already paid). Once both parties have met all contingencies, the escrow company will prepare a new deed in the buyer's name.
After signing (a bunch) of legal documents, the buyer will officially become the owner of the house and receive the keys. The funds will then be transferred to the seller, and the transaction is over.
Final Notes
While escrow might seem complicated, you won’t have to worry about it much. Typically, your agent or lender will handle the fine details and tell you exactly what steps you need to take.
We hope you found this article helpful. If you have any more questions, feel free to reach out or leave a comment below, and we'd be happy to help!