What Is an Escrow & How Does It Work?
Whether you are buying or selling a home, a lot of money is changing hands. You want to be sure that money is safe at every stage of the sale. If you’re the buyer, you want to be sure all the conditions are met by the seller before the funds are released to them. As the seller, you want to be sure the buyer has the funds they need and that those funds are protected until closing.
This is where an escrow comes in. If you’ve ever about the ins and outs of an escrow, this is where you will find all the information you need to learn what an escrow is and how it functions to ensure the sale of a home goes smoothly.
What Is an Escrow?
Escrow is a legal term that defines an arrangement where a third-party holds the money involved in the sale or ownership of a property. This money is held until a payment is due or the required conditions are met during a sale, such as fulfilling the purchase agreement or holding some of the funds until a final walkthrough is completed to the buyer’s satisfaction.
Types of Escrow
There are two primary types of escrow that are involved in the purchase of a property. One acts to protect the buyer and the seller during the sale of the house and the other acts to hold funds for the homeowner so they can pay their insurance and taxes.
Real Estate Escrow Account
This escrow account is designed to ensure both the buyer and seller are protected. The seller can rest assured that the money is available and set aside for when the sale goes through, and the buyer will have the peace of mind of knowing that the payment won’t be released until all the escrow conditions are met.
When you are buying a home, you will need to deposit the following into a real estate escrow account during the purchase:
- Earnest payment: This is a small deposit that shows you are serious about buying a home and have the means to do so. The seller gets to keep this money if you can’t follow through with the purchase. If you do purchase the home, this will form part of your down payment.
- Down payment: When it is time to make the down payment for your home, you will send a cashier’s check or wire transfer to the escrow company for the balance of the down payment.
In some cases, there will be an escrow holdback. This is when a portion of the funds are held in the account past the closing. This can be done for a variety of reasons, such as a release of the funds after a final walkthrough reveals no issues. If you are buying a new construction home, the escrow holdback may be release only after you sign off on the work done on your new home.
Mortgage Escrow Account
This escrow is often set up by your lender after you buy your home. It will hold a portion of your monthly mortgage payments for your insurance and taxes. This money will then be paid out when these funds are due.
Each year, the amount that will be set aside will be based on your payments for the previous year and there will be the base amount plus two additional months’ worth of payments set aside. Keep in mind that an escrow does not cover expenses such as utility payments or your homeowner’s insurance. In addition, if you receive any supplemental tax bills, they won’t be covered.
How Does an Escrow Work?
When it comes to the real estate escrow, the account is set up by the real estate agent. Depending on where you are, you may have a choice of which escrow agency you use. The escrow agreement will be created jointly by the seller, buyer, and lender. This agreement will lay out the amount of money the buyer must deposit into the escrow and all the conditions the seller has to meet for the funds to be released.
The escrow agreement will also describe what happens to the funds should the sale fall through on the part of the seller or the buyer. If the buyer backs out, the money goes back to the buyer minus earnest money, which is paid out to the seller. If the seller backs out, all the money in escrow is returned to the buyer.
The agreement is signed by everyone involved and then it is sent to the escrow agency, where the escrow officer will ensure the documents and funds are processed as specified in the escrow instructions. This agency is a completely separate entity from the lender.
The buyer’s real estate agent will deposit the funds into the escrow at the appropriate times. Then then escrow agency will follow the instructions established by the buyer or their agent as to when to release those funds. This is done only when all the escrow conditions are met, and the relevant documents are signed.
Disbursement of the Escrow Funds
The escrow funds are disbursed, and the escrow closed at the closing of the sale, once all the paperwork is signed. The loan paperwork will be sent to the lender by the escrow officer and the lender will make sure everything is in order.
Once this is done, the lender will give the go ahead to transfer the escrow funds to the seller. The mortgage funds are also transferred to the seller at this time. The escrow is then closed, and the sale of the property is complete.
Have questions about escrow or any other aspect of the sale of a home? Reach out to us today and speak with one of our experienced team members .
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