Simply put, escrow is an arrangement with a third party who is uninvolved with the buying and selling of a home. This means that this party is neither the buyer nor the seller. In real estate transactions, escrow holds all funds that are associated with the transfer of title, as well as maintains all documents and contracts.
To expand, escrow refers to a legal arrangement in which a third party temporarily holds a considerable amount of money or property, until a specific condition has been met. The most common example of such a condition would be the fulfillment of a purchase agreement. Escrow is used in real estate transactions to protect both the buyer and the seller throughout the home buying process throughout the term of the mortgage. This escrow account will hold funds for the purposes of taxes and homeowner’s insurance.
In a real estate context, escrow is generally used to protect the buyer’s good faith deposit, so that the money goes to the correct party according to the conditions of the sale. Escrow is also used to hold a homeowner’s funds for taxes and insurance purposes.
Because escrow can serve different purposes, there are two types of escrow accounts. One type is used during the home buying process, while the other type is used throughout the life of the loan. When a person is buying a home, the purchase agreement will generally include a good faith deposit which shows that they are serious about purchasing the home. If the contract falls through at the fault of the buyer, the seller generally keeps this money. Alternatively, if the home purchase is successful, the deposit will be applied to the buyer’s down payment.
In order to protect both the buyer and the seller, an escrow account will be set up, and the good faith deposit will remain in this account until the transaction closes. The cash amount is then applied to the down payment.
If you are building a new home, money may remain in escrow until you have signed off on all the work; once the conditions are met, the money will be released to the correct party. After purchasing a home, your lender may establish an escrow account in order to pay for your taxes and insurance. Once closing has completed, your lender will take a portion of your monthly mortgage payment and hold it in the escrow account until your tax and insurance payments are due.
The amount of money that is required for escrow can vary greatly, as your tax bill and insurance premiums can change from year to year. As such, your servicer or lender will determine your escrow payments for the next year, which is based on what bills they paid the previous year. In order to ensure there is enough cash in escrow, most lenders require approximately 2 months’ worth of extra payments to be held in your account.
In order to ensure that they are not collecting too much or too little, your lender or servicer will analyze your escrow account annually. If they determine that they have collected too much money for taxes and insurance, they will provide you with an escrow refund. If they determine that they have collected too little, you will be responsible for covering the difference.
Why Is Escrow Important In Real Estate Transactions? Who Is Generally Involved In Escrow?
To reiterate, escrow is important in real estate transactions because it ensures that a neutral third-party handles the documents and finances that are associated with the transaction. In that context, escrow helps make the transaction safer by ensuring that both the buyer and seller meet their obligations.
Additionally, escrow ensures that finances are not exchanged between the buyer and seller personally. As such, if one party fails to perform on their obligation, the other party does not automatically receive the money.
Generally speaking, there are three parties involved in escrow in any real estate transaction:
- Buyer: The buyer, who is also known as the promisor in a contract, agrees to buy real estate in a real estate contract. In exchange for an agreed-upon amount which is known as the purchase price, the seller (or promisee) agrees to transfer title to the buyer. The buyer has a specific amount of time in which to perform their end of the bargain, per the terms of the contract. This amount of time varies by contract;
- Seller: As previously mentioned, the seller is also known as the “promisee,” and is the party who has title to the real estate and sells this property to the buyer. Similar to the buyer, the seller has a specific amount of time in which to perform their end of the bargain per the terms of the contract; and
- Third Party, or Escrow Agent: The neutral third party is often the escrow agent. However, in some states, an attorney is used instead of an escrow agent. The agent’s job is to hold the documents and monies that are part of the transaction in escrow, at least until both parties perform their required tasks assigned by the contract. Once the specific duties have been completed by both parties, the escrow agent coordinates closing procedures.
Generally speaking, either the buyer or the seller is allowed to open escrow. However, in common transactions, the party who pays the escrow fees can choose where to open escrow. Whether the buyer or the seller pays the escrow fees depends on the state in which you reside.
How Does Escrow Work?
To simplify what was previously discussed, the escrow process is generally as follows:
- The buyer and seller agree to the terms of the sale and purchase of real estate;
- Either the buyer or the seller opens escrow;
- Both parties send all contract documentation to escrow;
- The buyer deposits their earnest (or good faith) money deposit into escrow;
- The escrow agent maintains all pertinent dates as per the terms of the purchase contract;
- The escrow agent holds all deposits or additional monies that are deposited in escrow, to be disbursed at the end of escrow;
- Escrow coordinates the signing of final closing documents, by both buyer and seller, in order to transfer the deed of title into the seller’s name;
- Escrow receives documentation from the buyer’s lender, as well as purchase funds from the lender; and
- Escrow disburses the money from the buyer’s lender to the seller’s account.
Do I Need An Attorney For Assistance With Escrow In Real Estate Transactions?
Generally speaking, a real estate attorney is not used as an escrow agent. Rather, they are often involved at other stages of a real estate transaction. Real estate agents are more familiar with the escrow process, and generally have escrow agents that they prefer to work with.
If your escrow agent fails to perform their duties during the escrow process, or you are experiencing any other disputes associated with escrow in real estate transactions, you should contact an experienced and local real estate attorney immediately.
A local lawyer will be best aware of your state’s laws concerning real estate and escrow, and how those laws may affect your legal options and rights. Additionally, a real estate lawyer will also be able to represent you in court as needed.