What is Escrow?
There are at least two real estate meanings for the term “Escrow.”
First (and most common): Escrow refers to putting something of value, usually money, into the care of a third party.
The primary purpose of this is to have a trusted, neutral stakeholder hold the seller’s deed to the property until it is delivered to the buyer upon fulfillment of the sales price and other sales conditions.
Second (less common): Escrow can also refer to the mortgage lender requiring the borrower to pay 1/12th of the annual estimated property taxes and hazard insurance each month, into an account maintained by the lender.
The lender pays the property tax and insurance bills from these funds when they become due. The lender also earns a modest extra income from the use of the escrow funds.
This article will focus on the first definition of escrow.
How Escrow Works
Escrow protects all the relevant parties by ensuring that no funds or property change hands until all conditions in the agreement have been met.
Until the process is completed, funds stay in the hands of a third party to make sure everything proceeds smoothly during closing, including transfers of money and documents.
Who the escrow officer is can vary by state. It might be:
• Someone from the closing company
• An attorney
• A title company agent
Contingencies that might be part of the process could include:
• Home inspection
• Other tasks that need to be accomplished by the buyer or seller
Every time one of these tasks is accomplished, the buyer and seller sign off on a contingency release form, and the process moves on to the next step.
When all the conditions are met:
• The deal is finalized
• The funds are transferred to the seller
• The escrow officer clears the title (which means the buyer officially owns the home)
How Much Does Escrow Cost?
It varies, but usually totals about 1%-2% of the cost of the home. The buyer or the seller can foot the bill, or they can split it, depending on their arrangement.
What Happens to the Money in Escrow if the Sale Does Not Happen?
Some reasons a real estate sale might not close are:
• Financing falls through
• Appraisals come in low
• Home inspections reveal major problems
• Title searches reveal significant issues
• Buyer can’t sell their current home
For these reasons and others, a sale can “fall out” of escrow. What happens to the escrow funds can vary based on several factors, including who was “at fault” for the failure. If the buyer is at fault for cancelling without good reason, they may have to forfeit their deposit to the seller. If the seller’s actions caused the failure, the buyer will get a full refund.
Most purchase agreements contain details about what will happen to escrow funds in a variety of situations – make sure you know what yours says!
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