How Escrow Works
For many people, a house is the most expensive purchase they will ever make. Since real estate transactions are complex and lengthy, many homebuyers use an escrow company or agent to manage their funds.
This article will explore the escrow process and how escrow works in homebuying.
What Is Escrow?
Escrow refers to a type of account used in a real estate transaction. Alternate terms include escrow company or escrow agent. An escrow company or agent is a neutral third party that handles aspects of the transaction. Using an escrow account protects the lender, the seller, and the buyer/borrower, reassuring them during the home purchase transaction.
Anyone can misuse or steal funds intended for the new home purchase without an escrow account. The time frame for using an escrow account is not limited to closing on the real estate transaction. Lenders often require borrowers to maintain an escrow account to cover closing costs.
Types of Escrow Accounts
There are several types of escrow accounts for real estate transactions. The first is a homebuyer's escrow account. The second is a homeowner's escrow account.
Homebuyer's Escrow Accounts
Escrow accounts for homebuyers hold funds, including your good faith deposit, during the homebuying process. This type of escrow account is a mortgage escrow account. These accounts hold and distribute funds for the mortgage lender. Your mortgage lender will set your escrow payments.
Homeowner's Escrow Accounts
Escrow payments during homeownership often include the following:
- Monthly mortgage payments
- Home insurance payments
- Property taxes
Using an Escrow Account
If you are a first-time homebuyer and unfamiliar with escrow, you should understand how it works. Once the seller accepts an offer on their home, the mortgage company will open an escrow account for the borrower.
Borrowers typically deposit the following into the escrow account before closing:
- Down payment
- Earnest deposit
The escrow company can fulfill its responsibilities once the buyer deposits funds into the account.
Escrow Company Responsibilities
The escrow company holds the deposited funds throughout the closing process.
The following is a list of escrow services most escrow companies offer:
- Receive the amount of the loan from the lender, often through a wire transfer
- Pay the title company for a title search and title report
- Pay the closing costs out of the escrow funds
- Transfer and record the deed to the buyer or title company
- Protect the lender by filing and recording the mortgage with the local recorder of deeds
- Any other financial transaction associated with closing the real estate transaction
Who Handles Escrow?
The party who manages the escrow account and performs escrow functions differs from state to state. In some states, a licensed title insurance company or an escrow company handles these functions. In other states, an attorney performs these functions.
In many states, escrow agents need a license to conduct business. Additionally, the escrow agent cannot be associated with the transaction. For example, the buyer's real estate agent or the seller's attorney cannot hold the escrow account. They may, however, recommend escrow agents whom they have used.
Escrow and the Homebuying Process
The homebuyer and seller usually pick an escrow agent while negotiating the purchase contract. They can also draft specific instructions for the escrow agent. The agent will then collect the earnest money deposit and the purchase agreement. The goal of the purchase process is to finalize the mortgage.
Finalizing the mortgage may include the following:
- A home inspection
- A title report and title insurance
- Acquiring homeowner's insurance
- Comparing the final mortgage offer with the good faith estimate
- Final walkthrough
After the buyer completes these steps, the escrow agent will collect the loan from the lender.
The escrow agent must disburse funds for the following after receiving the loan money:
- Insurance premiums
- Escrow fees
- Realtor or real estate agent commissions
- Mortgage satisfaction and recording costs
The seller receives funds, via transfer, after deductions, including the purchase price.
Home sales are often complex transactions with many moving parts. Escrow accounts offer all appropriate parties some assurance during the entire transaction. If you are purchasing a home, a qualified local real estate attorney can help you throughout the process, including finding an escrow company.
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