Escrow Explained: What Buyers Need to Know

Buying a home can be a complicated process filled with phrases and concepts that are difficult for many people to understand. One such term commonly used during the home buying process is “escrow”.

Let’s take a deeper look at this concept, as well as what it means for homebuyers.

What is Escrow? 

According to Investopedia, escrow refers to assets held by a third party on behalf of two other parties who are completing a transaction. 

Types of Escrow Accounts

In the real estate business, escrow is typically used for protecting a buyer’s deposit until the conditions outlined in the purchase agreement are met by both the buyer and seller. 

Escrow may also be utilized to hold a homeowner’s money for the payment of property taxes and insurance. That said, it is important to understand that taxes and insurance fees are not charged by the bank/lender and the amount due for local taxes and insurance premiums are subject to change over time. An “Escrow Analysis” will be conducted on an annual basis to determine if the correct amount has been escrowed. 

What Does The Phrase “Being in Escrow” mean?

The phrase “being in escrow” refers to a part of the home buying process– more specifically, the period between when a seller accepts an offer and when the buyer closes on their new home. 

Escrow Process for Purchasing a Home

While the length of the escrow period can vary from state to state, the key steps of the escrow process tend to remain the same for all homebuyers. 

1.  Earnest Money Deposit 

Once a buyer and seller have executed a purchase agreement, a real estate agent will typically collect earnest money from the buyer and deposit the funds into an escrow account. The amount due, as well as the name and address of the escrow company will be outlined within the terms of the purchase agreement. 

2. Lender’s Appraisal

Most often, the buyer will pay for an appraisal to be completed, which protects not only the buyer’s financial interests, but the mortgage company, as well. If the bank appraises the property under the purchase price, the lender will likely not approve financing unless the buyer can pay the difference in cash or the seller lowers the price to the appraised amount. 

3. Obtain Financing

The next step is to secure financing. Typically, the buyer has been pre-approved for a mortgage well in advance of executing a purchase agreement. The buyer must provide the lender with the address of the property to be purchased and the lender will prepare a Loan Estimate, which is a document that outlines the loan amount, interest rate, closing costs, and any other fees associated with purchasing the home. Always negotiate the fees included in this document to make sure you’re getting the best deal possible! Once a buyer has a written loan commitment, then the financing contingency may be removed in writing. 

4. Approve the Seller’s Disclosures

Most often, the seller’s agent will provide a written list of any obvious problems with the property. The buyer needs to be aware of any potential issues before closing.

5. Inspections

Although not a requirement, it’s highly recommended that a buyer get a thorough home inspection before closing. A professional home inspector will provide valuable information to the buyer, including whether or not there are any dangerous or costly problems with the property (example: bad plumbing, missing shingles, wood rot, etc.). 

If a home inspector does find problems with the property, the buyer may be able to back out of the purchase, ask the seller to fix the problems, or ask the seller to lower the purchase price to accommodate the cost of necessary home repairs. 

In addition to the home inspection, buyers should consider a pest inspection, environmental inspection, and geologic report (especially for properties located in areas subject to earthquakes). 

6. Hazard Insurance, Title Report & Title Insurance 

Until a mortgage is paid in full, buyers will be required to have homeowners insurance. Furthermore, depending upon a buyer’s geographic area, additional coverage may be required such as flood insurance. 

In addition to homeowners insurance, title reports and title insurance will be required by the lender. 

7. Final Property Walk-Through

Just before closing, it is highly recommended for the buyer to re-inspect the property to make sure no new damage has occurred and the house is in good working order. Unless the home has sustained serious damage, it is unlikely the buyer will be able to back out of the purchase. 

8. Closing Disclosure

Three days prior to closing, the buyer will receive a Closing Disclosure, which is simply a form that outlines a final statement of loan terms and closing costs. Buyers should take the time to compare this document to the loan commitment received at the start of this process from their lender. 

9. Property Closing

Time to celebrate! This is the final step of the home buying process and it is sure to involve a lot of paperwork on behalf of the buyer and seller. After the paperwork is complete, the escrow officer will prepare a new deed to the property, naming the buyer as the new property owner. The buyer will also submit a cashier’s check or schedule a wire transfer to satisfy the downpayment and pay for closing costs while the lender will wire loan funds to escrow so the seller and seller’s lender (if applicable) can be paid. 

Ultimately, escrow is an important part of purchasing a home because it protects buyers and sellers during the sale of a property and provides a simple way for homeowners to pay for taxes and insurance.