When you are buying a home, some parts of the transaction can be confusing, and the escrow meaning is one of them. It is not unusual for homebuyers to ask, what is an escrow account and how will it affect me in the buying process?
Having escrow funds ensures that the buyer has some skin in the game and will not walk from the transaction.
Let's look at how escrow works and what you need to know when you encounter this when buying a home. As a first-time homebuyer, it is one of the essential things to know about.
What is an Escrow?
Escrow deposits are a way for a third party to hold onto an asset until both sides of the financial transaction have completed their obligations.
When you buy a home, this will mean giving your earnest money deposit to a third party until closing. This money is placed in an escrow account until the purchase agreement conditions have been met.
The escrow held is typically one to five percent of the purchase price. It can vary tremendously based on where you're located and familiar traditions.
After getting an accepted offer on a home, it will mean handing over a check to your escrow agent to be safely deposited with the escrow company. The company is the third party that will oversee some of the documents and funds involved at the start of the process and at closing.
Escrow funds are almost always held by one of three parties—a real estate broker, an escrow company or an attorney.
Let’s look at some of the stages you’ll need to go through before your funds are released from escrow and close on the home.
Home Loan Approval
Before you make an offer on a home, you should have already received pre-approval for a mortgage. When you have the address of the home you want to buy, your lender can begin the underwriting process to approve the loan.
Your lender will give you a breakdown of your closing costs and other fees. They will also need an appraisal of the home to know they aren’t lending more than it is worth.
Should you end up in foreclosure, the lender doesn’t want to lose out financially. The buyer will pay for a house appraisal, and the result could be a problem if it finds the value is less than the offer amount. If that happens, you aren’t going to get the loan you expect unless you can pay the difference or negotiate with the seller to reduce the price.
If the appraisal is lower than you expect, there are other options, like changing lenders and getting another estimate. You can also challenge the finding, though you will need some solid evidence to prove the home is worth more.
If none of these options resolves the situation, you can still walk away from the deal. But if the appraisal is dealt with, the contingency can be removed.
If your lender hasn’t found any problems with your application, they should give you a written loan commitment. At this point, any financing contingency has been fulfilled and you are closer to owning the home.
Seller Disclosures
If there are any problems that the seller or their real estate agent is aware of, they will create a written notification. Perhaps, something about the home doesn’t meet the housing code, and it hasn’t been previously mentioned in the listing.
Even if there isn’t this type of disclosure, any problems should be revealed in the home inspection. While you don’t have to get the home inspected, it is in your best interests to do so. There are other inspections you might need as well:
Pest Inspection - To check for termites and other problems
Environmental Inspection - To look for mold, radon, and any potential contamination from hazardous materials.
Geologic Check - If the home is in an earthquake or flood zone.
Title Insurance
Lenders typically require title insurance and title reports. The report ensures that there isn't a problem with the title, like liens or other claims to the home. If someone makes a claim of ownership over the house in the future, title insurance ensures the lender is covered.
Buyers have the option to purchase their own title insurance policy. When getting a home loan, every lender will require a buyer to buy lender's title insurance.
Final Walk-Through
When you are through the other stages, it is advisable to make a last check of the home before closing. This will let you make sure the house is in the same condition and that items have been left that were agreed upon.
Closing Escrow
At closing, you will have documents to check and sign. It would be best to take your time to ensure that everything is as it should be. With signatures on all the dotted lines, you’ll need to pay your down payment with a cashier’s check or wire transfer.
The escrow company will now release your earnest money to help you cover the costs required at closing. You will also be given the keys as the home's new owner.
Final Thoughts
Understanding how escrow works in real estate is essential for buyers and sellers. It is not uncommon for disputes over escrow deposits if a home sale goes south. It is crucial to understand that the third party holding the money cannot release the funds to either party during a dispute.
If there is no resolution with dispersing the funds, the court will eventually decide it.
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