Real Estate Escrow: What Is It? And How Does It Work?

Whenever it comes to the topic of real estate, there’s an entire dictionary worth of words that are thrown at our heads. There are multiple things to take care of and jargon for pretty much all of them. The one term that is very frequently heard, amongst all others, is ‘escrow’.

A lot of the time you’ll hear this term along with others like ‘escrow agent’ and ‘escrow account’. Once you start the process of buying or selling any sort of real estate, these terms can get pretty confusing, especially when a third party is involved in the process with the specific intent of working on the same, confusing topic. Hence, we’ll explore the meaning of real estate escrow and everything related to it in this article.

What Does Escrow Mean?

In essence, the term escrow is a legal arrangement in which a neutral third-party is assigned to hold on to funds during a transaction until all terms and conditions set by all parties are met. It’s a way to protect the buyer and the seller from any malintent or mishap.

When it comes to real estate, the buyer puts money into the escrow in order to pay for any insurance payments, mortgage, and any other payments regarding the sale. This process continues throughout the term of the mortgage.

Types Of Escrow Accounts

Effectively, there are two types of escrow accounts. The first one protects the amount of money that a buyer might put up as a good faith deposit against the property while the second type of escrow account looks after insurance and taxes for the homeowner.

Escrow Account For Home Buying

Whenever there’s a proposition to buy a house, it’s normal to deposit a percentage of the house’s total price in the escrow as a token of good faith. This ‘good faith deposit’, or earnest money, is generally an indicator of the seriousness of the buyer’s claim of purchase. Typically, if the deal fails, this amount goes to the seller. However, if the sale is successful, all the earnest money goes towards the buyer’s down payment.

Regardless of whether the deal is successful or falls through, this amount is generally only held in escrow until the transaction closes. However, in some cases, the earnest money can be held back for some time after the transaction closes.

This holding of money is called ‘escrow holdback’ and can be brought into action for multiple reasons like a discrepancy in the documents or the seller being allowed to stay in the house for any amount of time after the sale. If the escrow is being held over a house that is being built, the money might be held in escrow until the owner signs off on all the work and equipment. As soon as the conditions of the contract are met, the money is released to its rightful recipients.

Escrow Account For Tdaxes And Insurance

The second type of escrow account is the one that a lender might set up after a buyer purchases a house. After the deal is closed, the lender takes a part of the monthly mortgage payments and holds them in escrow to take care of all taxes and insurance payments.

The insurance premium and the taxes are dynamic. While they mostly stay in the same ballpark, they can change every year. In this case, your lender determines the total amount to be paid per year based on the bills that were paid one year earlier.

Sometimes, in order to make sure seamless payments, the lender might decide that your escrow account needs two months’ worth of mortgage payments. In some cases, the lender might collect more money than deemed necessary. In which case, you’re eligible for what’s called an ‘escrow refund’.

However, if they seem to have collected less than what’s necessary to pay all the taxes and insurance payments, you’ll have to catch up to the amount required. This is done in two ways: you’ll have to increase the amount for your monthly mortgage payment or make a one-time payment and keep the same monthly payments.

Also See: Tips to Pay-off Mortgage Faster

The Process Of Escrow

After understanding the concept of escrow, the types of escrow accounts, and their application, the next step is to choose the option that suits you best. However, how do you make the best choice? Firstly, you have to remember that the escrow amount is generally between 1 to 3 percent of the total sale price.

After the seller and the buyer decide on the sale price and all other terms of sale, a trusted third party is appointed as the escrow agent. This escrow agent is responsible for the safekeeping of the escrow amount in an escrow account until the title is transferred to the buyer.

During the term of the escrow, the money in the escrow account is inaccessible to all parties involved. Depending upon the fate of the deal, the funds in escrow are either returned to the buyer or applied towards the down payment of the house.

Benefits Of An Escrow Account

An escrow account is neutral and managed by a trusted third party. The biggest benefit of this is that it can protect the buyer as well as the seller from any mishap in the sale. However, that’s not it. Escrow has a lot of benefits for all parties included. Check them out!

For Buyers

As a buyer in the market, having an escrow account helps you in many ways. It not only protects any sort of deposit that you put towards the house but also gives the seller the confidence that you’re very serious about buying the property, giving you an edge over the others.

As a buyer, once you deposit any money into the account, it will be applied towards the down payment or the mortgage of the house. However, having an escrow account also makes sure that all the money you have put in that account comes back to you in case the deal falls through.

See Also: Shortlisting Buyers for Home

For Homeowners

Once a deal is closed and you’re the owner of a place, an escrow account helps in cushioning the responsibility of all the different payments that come with it. For example, the lump sum collected in your escrow account will take care of all the taxes and insurance payments. Since these payments are made throughout the year, making these payments becomes much more manageable.

The bigger benefit is that your mortgage servicer will take care of all the payments. Meaning, you don’t have to worry about the due dates and amounts for all the tax and insurance payments.

For Lenders

Since the lender becomes responsible for any liability to the property until the mortgage is cleared, they have to make sure that the insurance and taxes get taken care of. In any case if the taxes and the insurance payments for any property are not made on time, the bank may choose to foreclose the home, or fine the lender.

In either case, the lender can go through severe losses. Hence, a lender has to make sure all payments happen on time. Having an escrow account makes this home buying process easier for the lender as well.

Disadvantages Of An Escrow Account

While having an escrow account is mostly helpful to all the parties, it also puts all parties involved in certain situations that might be more of a problem, if not handled correctly. The homeowner has the biggest disadvantage here since they’re the only entity that’s responsible for the house.

Higher Mortgage Payments

First and foremost, the most obvious disadvantage of an escrow account can be higher mortgage payments. Since your escrow account receives a part of your mortgage payments, it increases the monthly payments by a considerable amount.

Chances For Incorrect Estimates

Secondly, your mortgage servicer is responsible for the payments along with the insurance and tax payments. So there’s a chance that at some point there will be an incorrect estimation of the funds needed in escrow, effectively disrupting the payments and putting you and your house under the scanner.

This can happen due to many reasons. The most common one that we have seen is the failure to consider that change in the value of a property after the owner has moved in. If this does happen, your escrow will come up insufficient and you’ll have to pay the difference out of your own pocket.

Does Not Cover All Expenses

While escrow does cover a lot of the costs associated with real estate transactions and homeownership, it does not cover all of them. For example, the money you put into escrow will not be used for paying Homeowner’s Association fees, utility fees, or any other payments like supplemental tax bills.

Escrow Amount To Pay Can Change – For Better Or For Worse

Lastly, depending on whether your escrow had excess money, or came up short in a year, you might witness a change in your mortgage payment. To put it a little more clearly, you’ll have to pay more in terms of the mortgage if your escrow comes up short at the end of the year. However, if it happens to be the other way around, you might as well see a decrease in your payments or a streamlined amount for a long period of time.

Things To Keep In Mind About Escrow

Regardless of whether you’re the buyer or seller in a real estate transaction, you have one of the most important roles in the entire process. There are many tasks other than being responsible for the money. One of the first ones is to be aware and extremely careful each step of the way. Some of the other ones include:

  • Reading and understanding all documents related to the escrow. If you do not understand any part of it, it’s your job to talk to the concerned person and clarify all doubts before proceeding with a deal.
  • Glancing through the closing documents with a fine comb and making sure that there are no surprises for you, for the escrow agent, and the other party in the sale. Remember that last-minute discrepancies tend to diminish all faith, resulting in complications, and sometimes total failure of the deal.
  • Make sure that you have all the escrow-related documents available to you. Be available to the third party entrusted with the escrow as well as the other party of the sale.
  • This to-do list might sound a little arbitrary. That is because it is. Most of the tasks related to an escrow are conducted behind the scenes, by the escrow agent, without the explicit knowledge of both parties. Due to this, all that you can do is make sure you have the funds, the paperwork, and yourself ready for any conversation that might arise between you, your lender, your escrow agent, or any other party to the sale.

Conclusion

The first step to understanding real estate escrow is to understand why it is put in place. From a distance, it might seem like a process put in place to keep all transfers of funds as transparent as possible. However, a properly executed escrow protects the buyer, seller, and lender. Not just that, it also gives all the parties the opportunity to see a deal through without the stress of dealing with its financial aspects.

As confusing as real estate escrow might sound, it’s one of the best tools to provide you with the peace of mind to actually participate in the process of getting your new home and enjoying it, too!

See also: What is Escrow and How Does it Work?

FAQs On Real Estate Escrow

Is Escrow Good Or Bad?

There’s no direct answer to this question. Depending upon your personal situation, an escrow might be good or bad for you. However, escrow is typically in place to facilitate a sale and to protect all parties involved in it.

What Happens When A House Is In Escrow?

When a house is in escrow, it means that the sale of that house is already under process and the money is being secured by a third party. A house typically remains under escrow until the mortgage payments are finished.

How Can I Get Rid Of Escrow?

The procedure to get rid of an escrow account is very straightforward. You must simply make a written request to the lender or loan servicer. This letter might also be called an escrow waiver, cancellation, or removal request.

Can I Pay Escrow Myself?

Yes, you may be able to cancel your mortgage escrow account and pay the insurance and taxes on your own.

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Written by


Rostislav Shetman is the founder of 9Kilo Moving. He has been in the moving and relocation industry for more than 25 years, making him an expert in his field. Rostislav started as a helper, dispatcher and driver and has worked his way up to owning his own company. He takes great pride in his work and enjoys helping people relocate across the United States of America. When he's not working, Rostislav enjoys spending time with his family and friends. They are the light of his life and bring him happiness every day.