Understanding Escrow: A Key Component of Real Estate Transactions
In this article, we will explore the essential role of escrow in real estate, its functions, benefits, and considerations for buyers and sellers.
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.
What Is Escrow?
Escrow is a legal arrangement involving a neutral third party called an escrow agent. This agent holds money or property until certain conditions are met. When you make an offer on a home, you might pay a good faith deposit. This deposit, also known as earnest money, shows you are serious about buying the home. The escrow agent holds the deposit in an escrow account until the sale is completed. The funds are released when 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 also holds funds for property taxes and homeowners insurance after you buy a home. Your lender requires you to pay a portion of your monthly mortgage payment into an escrow account. This account is used to pay these bills on your behalf. This arrangement helps you avoid late fees and penalties, ensuring 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.