What is Escrow

You’re under contract to buy the home of your dreams. You’ve filled out a thousand pages of paperwork, signed and initialed documents until your wrist hurts, and are approaching your closing date. Then your realtor starts talking about escrow. What in the world is that? Just when you thought you were done with confusing real estate terms, a new one pops up. But don’t worry, if you’re wondering what escrow is, you’re in the right place.

 

WHAT IS ESCROW?

Escrow is a legal arrangement where a third party (typically handled by your lender) holds onto money or collateral until a particular condition has been met. In real estate, this typically is an account that holds funds for taxes, homeowner’s insurance, earnest money, or even money that is designated for improvements on the house that have yet to happen.

ESCROW ACCOUNTS

There are two main kinds of escrow accounts—one for taxes and insurance, and one for home buying. Setting up an escrow account, which a realtor or lender will largely do for you, protects the buyer by ensuring that their deposit is going to the correct party according to the sale conditions. It is also a place a lender will hold funds for the property and taxes.

Oftentimes, buyers will pay property taxes and home insurance in a single payment upfront. This money goes into an escrow account that is managed by your lender. They will then disperse the money to the right parties when the time comes. No matter what reason you are using an escrow account, it is simply a third-party managed place to hold funds.

ESCROW ACCOUNTS FOR HOME BUYING

When you are buying a home, one of the first steps you take is to put down a “good faith” deposit called earnest money. This deposit is simply meant to demonstrate to the owner that you are serious about buying the home and are ready to put money down. Typically, if you decide not to purchase the home after your due diligence period has ended, this money goes to the owner for their lost time and wasted energy on you as a buyer. But while you

are under contract, getting inspections, and getting ready to close, your earnest money sits in an escrow account.

 

This is the ideal location for these funds because they do not yet belong to the owner of the home (that would happen at the close), but they also need to be outside of your possession to prove your seriousness in buying the house. The

home buying escrow account that is managed by a third party ultimately protects both the buyer and seller by ensuring that the conditions for sale are met. Finally, if you do close on your house, the earnest money that has been held in escrow gets applied to your down payment. The escrow account was simply holding it until the proper time.

 

ESCROW ACCOUNTS FOR TAXES AND INSURANCE

Alright, you made it to close! Congratulations! At this point, your lender will most likely set up an escrow account for you to pay your taxes and insurance. Typically, you will be asked to deposit two months of payments right away, but sometimes you will be asked for more upfront. Like the homebuying escrow account, the money that goes into your taxes and insurance escrow account is managed by someone other than you (your lender) and is distributed at the proper time (when your tax and insurance payments are due).

 

This account simply functions as a way for your lender to be confident that you are paying the necessary payments for property taxes and home insurance. Typically, lenders require an escrow account if you have less than 20% equity as a buyer. If you have more, your lender may not require this kind of escrow account. But if they do, it actually saves you some energy and upkeep because your lender is responsible to make the payments, not you. Furthermore, your lender is liable if they miss a payment for some reason. The money in the escrow account becomes their responsibility. Just be sure you remember not to pay any bills that come your way that you have already paid to your lender. You may get a home insurance bill or tax bill in the mail, but if you have already paid upfront into the escrow account with your lender, these bills are being managed by them.

WHAT ARE THE BENEFITS?

Maybe an escrow account feels like a frustrating in-between, but in reality, there are benefits to using these kinds of accounts. The biggest benefit is that

both sides of a real estate transaction are protected by an escrow account. In the home buying process, you can feel confident that if the inspections come back looking like more work than you signed up for, you can back out of the deal and get that earnest money back. Likewise, as the owner, if the buyer keeps you under contract for weeks and then decides to not buy, you have the peace of mind that you will actually get the earnest money.

 

Even more, though, lenders benefit from escrow accounts because you are paying certain costs upfront before you purchase your home. This gives lenders the confidence that they can and will be able to distribute the basic and necessary payments for home insurance and property taxes. All in all, escrow accounts are a big win when it comes to a real estate transaction.

Well, now that you know exactly what escrow is, you are ready to take on whatever part of the home buying process you find yourself in. Just remember, escrow is a legal arrangement where a third party holds onto money or collateral until a particular condition has been met. This typically is an account that holds funds for taxes and homeowner’s insurance, or money for the home buying process.

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