Escrow and the Role It Plays in the Home Buying Process

If you’re buying a home, you’ve probably heard your real estate agent mention the term “escrow.” However, you may be wondering, “What is escrow — and what role does it play in the home buying process?”

We’ve laid out a guide on escrow and its role in a real estate transaction. Read on below to learn what escrow is, how it works in real estate, and what it means for you as the buyer. Armed with this knowledge, you should feel relieved that your money will be kept safe until you’re ready to purchase your new home.

What is escrow?

At its core, escrow is a financial arrangement between two parties. It involves contracting with a third party to hold assets for the buyer and seller before the transaction is finalized. These assets typically include money or paperwork. Though, they can also include other items as well, depending on the specifics of your transaction.

The third party is not otherwise involved in the transaction and cannot have a stake in whether the buyer or the seller comes out ahead. This keeps everyone’s assets safe until both parties have held up their end of the bargain by meeting all of their responsibilities as outlined in the contract.

The role of escrow in a real estate transaction

After an offer is accepted, buyers are responsible for handing over their earnest money deposit.  It’s also sometimes known as an “escrow deposit.” This money shows that the buyer is serious about buying the home.

However, rather than being delivered directly to the seller, the money will be put into an escrow account. That third party — known as the escrow agent —  holds the deposit throughout the length of the negotiations. During that time, neither party will have the ability to access those funds.

Once mutual terms have been reached and both parties have fulfilled all of their obligations as outlined in the contract, the escrow agent will distribute all the funds exchanged in the transaction. In particular, the buyer’s earnest money deposit will be applied to their down payment.

What happens if the sale doesn’t go through?

Ideally, every real estate offer would eventually come to a positive resolution at settlement. However, that’s not always the case. In the event that the buyer and the seller choose to dissolve the deal, the escrow agent is still responsible for distributing funds where appropriate. How the funds are distributed depends on how the transaction comes to an end.

For the most part, when buyers decide not to buy a home, it’s because of a contingency. For example, sometimes the inspections will show that a property requires too much work for a buyer to handle. Alternatively, the buyer and the seller could be unable to reach new terms after an appraisal comes back lower than expected. In either case, since the buyer is leaving under acceptable terms in the contract, the escrow agent will give back the deposit money.

However, if the buyer decides to walk away from buying the home without adhering to the terms in the contract, they’re essentially forfeiting their right to the deposit money. In that case, the escrow agent must give the money to the seller.

Why is my lender talking about using an escrow account after settlement?

Often, after you close on a home, your lender will also use an escrow account. Lenders collect property tax payments and homeowners insurance payments as part of your monthly mortgage payments. Then, they make those payments on your behalf. As they collect the money for those payments, it will be stored in an escrow account.

Lenders prefer this method because it ensures that the home — which is backed by their loan — will not fall behind on its property tax and mortgage insurance payments.

Are there fees associated with using an escrow account?

Typically, the escrow agent — who is usually either an attorney or a title company employee — will charge a fee for managing of the escrow account. Usually, this fee amounts to around 1% of the home’s purchase price. It will be included in the closing costs for the home. The buyer and the seller are free to negotiate who will be responsible for paying those costs along with the other terms in the purchase agreement.

As for the escrow account that’s used to hold your property taxes and homeowners insurance fees, you probably won’t see a bill for this directly. However, odds are that the cost of keeping the account open will be rolled into your monthly payment.