What Is Escrow and How Does It Work in Real Estate?

If you are buying or selling a home, you may have heard the term escrow. But what does it mean and how does it work? In this blog post, we will explain the basics of escrow and how it can benefit you as a buyer or seller.

digital image created by ai depicting what escrow is and how it works in real estate

What Is Escrow?

Escrow is a legal arrangement in which a neutral third party, known as an escrow agent, holds money or property until a certain condition is met. For example, when you make an offer on a home, you may have to pay a good faith deposit (also called earnest money) that shows you are serious about buying the home. This deposit will be held in an escrow account by an escrow agent until the sale is completed and the home changes hands. This way, neither you nor the seller can touch the money until all the terms of the contract are fulfilled.

Escrow can also be used to hold funds for property taxes and homeowners insurance after you buy a home. Your lender may require you to pay a portion of your monthly mortgage payment into an escrow account that will be used to pay these bills on your behalf. This can help you avoid late fees and penalties and ensure that your property is always covered.

How Does Escrow Work?

There are two types of escrow accounts: one for the home buying process and one for taxes and insurance.

Escrow Accounts for Home Buying

When you buy a home, your purchase agreement will usually include a clause that requires you to pay a good faith deposit into an escrow account. The amount of the deposit may vary depending on the market and the seller’s preferences, but it is typically 1% to 2% of the purchase price. The deposit shows that you are committed to buying the home and protects the seller in case you back out of the deal without a valid reason.

The escrow agent will hold the deposit until the closing date, when all the conditions of the contract are met. These conditions may include getting an appraisal, a home inspection, a title search, and a mortgage approval. If everything goes smoothly, the deposit will be applied to your down payment or closing costs. If something goes wrong, such as the home failing the inspection or the appraisal coming in too low, you may be able to get your deposit back, depending on the terms of the contract.

Sometimes, funds may remain in escrow even after the sale is completed. This is called an escrow holdback. This may happen if you agree to let the seller stay in the home for a while after closing, or if you find something wrong with the property during the final walkthrough. The escrow agent will release the funds to the appropriate party once the issue is resolved.

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