If you’re about to buy a home, chances are you’ll hear the word ‘escrow’ at some point.
Escrow refers to a financial instrument, usually an account, that is managed by a neutral third party on behalf of two other parties engaged in a financial transaction, such as buying a home. Under this legal procedure, the money is held in the designated escrow account for a specified period, for example until a particular condition is met or until the purchase contract is fulfilled. Closing day, in other words (if we are talking about real estate transactions).
There are several steps in the escrow process and in some cases, depending on the amount of money you are putting on a home, escrow may not be necessary at all. Here’s what to expect in the escrow process.
How does escrow work when buying a home?
“Escrow” is short for escrow accounts. In real estate, there are three common types of escrow accounts.
Buying a house
The first type of escrow account is one used to purchase a home.
“The purchase agreement typically includes a provision for the buyer to provide a cash down payment,” says Tom Trott, branch manager for Embrace Home Loans in Frederick, Maryland.
The earnest money deposit – typically 1% to 2% of the purchase price of the home – is held in an escrow account until the contract is finalized, after which the funds will go to the down payment of the buyer or closing costs. If the agreement is cancelled, the deposit will go to the buyer or the seller, depending on what the contract stipulates.
Property taxes, home insurance and mortgage insurance
The second type of escrow account, aka a mortgage escrow account, comes into play once you have actually purchased a home. It’s managed by your mortgage lender or managing agent, and the funds in it are used to pay property taxes, home insurance, and mortgage insurance (if applicable).
Unresolved points in real estate contracts
A third type of escrow, if necessary, involves anything not resolved in the real estate contract.
“For example, if the seller left furniture behind, did not complete repairs, or the property was damaged, the settlement company may hold the seller’s funds in escrow until the contract is fulfilled” , explains Trott. “Once completed, the funds would either revert to the vendor or be used to pay outstanding bills.”
Is escrow required?
When buying a house, it is necessary to deposit money in an escrow account under certain circumstances. Typically, homebuyers are required to have an escrow account if their down payment is less than 20% of the home purchase.
In some cases, homebuyers are mandated by a mortgage lender to have an escrow account. If the home purchase is being paid for with a government guaranteed loan, such as an FHA loan or USDA loan, an escrow account will be required. The Veterans Administration (VA) does not require an escrow account for a VA loan, but the mortgage lender used to actually fund these types of loans may require one.
Escrow Process Steps
Once you have successfully bid on a home and signed a purchase and sale agreement with the seller, the escrow process begins, which includes several phases. Your deposit will remain in the escrow account throughout this process until you reach the final stage of the home purchase, which is closing.
1. Open an escrow account
The first step is to open an escrow account, which is usually done by the seller, but can also be done by the buyer.
“Once an offer is made and accepted, the contract will state when the escrow deposit is due,” said Ralph DiBugnara, president of Home Qualified, a real estate resource and web series. “In most cases, the deposit is split into two parts – first an initial good faith deposit followed by the rest of the deposit. Usually within 7-10 days of signing the contract. This deposit will eventually be applied to your down payment on the house.
The agent holding the escrow account may be a real estate title company, bank or other financial company, or it may be a private third party entrusted with the task. Alternatively, a real estate attorney can handle this process, in which case it might be called “settlement” instead of “receiver.”
2. Home Assessment and Inspection
Your mortgage lender will order a home appraisal. If the appraised value of the home is lower than the proposed purchase price, your lender will not provide funds for your mortgage unless you are willing to pay the difference in cash or the seller agrees to lower the price to the estimated value.
As a buyer, you have the option of hiring a home inspector to carefully assess the home and its livability. This is an important step in the escrow process that allows buyers to gain a deeper insight into the condition of the property, including its structural integrity, electrical and plumbing systems, heating and more.
“Most responsible realtors advise against foregoing an inspection,” said Katie Severance, realtor at Douglas Elliman in Palm Beach, Florida.
You will also want to review the vendor disclosures. The seller is required to report known negative conditions or defects that currently exist in the home, such as the presence of lead paint or asbestos.
3. Obtain insurance coverage
Your mortgage lender will require you to obtain home insurance for the property and pay for title insurance. Unless you obtain an additional homeowner’s policy, title insurance primarily protects the lender from any legal challenges that may arise due to defects in the title or ownership of the home.
4. Final walkthrough
Assuming all goes well with the appraisal and inspection – and nothing changes in your financial situation that could derail your mortgage approval – you will have the opportunity to view the home just before closing for a last visit. This helps to ensure that there is no further damage to the home and that the seller has complied with the terms of the purchase agreement, such as leaving behind appliances or accessories that they have been on. agreed.
“The purpose of the guided tour is to confirm that the house is in the same condition as it was on the day of the inspection,” Severance said. “Things to do include scouring the entire exterior of the property for any obvious issues.”
It’s also a good idea to check that the water pressure in the house is still good and that there have been no plumbing problems, which can be checked by running all sources of water. household water, including sinks, faucets, tubs, showers, and dishwashers. , says Severance.
Unless a major problem is discovered, buyers are generally not allowed to back out of the purchase at this point.
At least three business days before the transaction closes, you’ll receive a closing disclosure document from your lender with a finalized list of closing costs, including escrow amounts, Orlando explains. Compare this to your loan estimate (which you received when you applied for the loan) to ensure that there are no significant cost changes.
When it’s time to close, the escrow agent will create a document naming you as the owner and file it with the local records office, then transfer the funds to your escrow account so that the seller and lender of the seller can be paid. For the remaining deposit and closing costs, you will need a cashier’s check.
Escrow accounts for owners
After you buy your home, another type of escrow account is operated by your mortgage lender or manager, with the funds in this account used to pay your property taxes, homeowners insurance, and (if you need them) your mortgage insurance. .
Your lender will divide these annual costs by 12 months and add them to your monthly mortgage payment. When your property taxes, home insurance, or mortgage insurance bills are due, the mortgage agent or lender will automatically pay the bills on your behalf from your escrow account balance.
Once a year, usually at the end of the year, you will receive an escrow account statement, which includes information on your insurance and property tax costs, and also indicates whether you have a deficit or surplus in your escrow account at the end of the year. These statements also show whether your escrow payments will increase, decrease, or stay the same over the coming year.
Maintaining an escrow account can provide peace of mind — it ensures your bills are paid on time, and you won’t have to keep up with them, says Holsted. Many owners choose to have them for this reason.
If you chose to have a mortgage escrow account for convenience, you can usually close it at any time. If the escrow account was mandated by your lender, it gets more complicated. You will eventually be able to terminate a mortgage escrow account, although restrictions on this vary from lender to lender. You’ll need to be in good standing with your payments, Solomon says. And often, having accumulated at least 20% of the equity in your home, which means you no longer have to pay for mortgage insurance.