Real Estate 101: What is Escrow?
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If you’ve ever purchased a house before—or if you’re in the process of doing it—it’s a word you’ll hear mentioned a hundred times or more both by your lender and your real estate agent: escrow. But what is escrow, exactly? What does it have to do with buying a home? First off, let’s start with the Merriam Webster definition of the word escrow:
Es-crow (eskro), noun: A bond, deed, or other document kept in the custody of a third party, taking effect only when a specific condition has been fulfilled.
That seems simple enough: A third party who receives something and holds onto it and then disburses it when certain conditions have been met. In real estate, that’s exactly what an escrow company does: it hangs onto money and documents that are needed for the real estate transaction to process and distributes them to the correct parties at the correct times.
Escrow protects both the buyer and the seller because while it shows the payments have been made, they cannot be utilized by the receiving party until the conditions are met for their disbursal.
Earnest Money
One of the first payments you will make into escrow will be your earnest money payment. This is a good faith financial gesture on the buyer’s behalf that shows a financial interest on following through with the loan so that the sellers can be confident that you will meet the contingencies laid out in your offer.
Your earnest money check is, for all intent and purpose, a deposit on your intent to purchase the home in which you’ve placed the offer (once the seller has accepted it). The seller cannot touch your earnest money payment, but they can rest assured that it’s sitting in an account waiting for the time to disburse.
Other Items That Go to Escrow
Nearly every financial transaction that accompanies the buying or selling of a home will pass into escrow at some point or another. This is because the escrow company works both between the buyer and the seller and the buyer and the lender. These can include tax payments, down payments, homeowner’s insurance premiums, and HOA or condo association fees (in some cases). This benefits you as a homeowner and makes organizing your finances simpler.
Why Escrow Exists
As mentioned above, escrow protects both the seller and the buyer during the sale of a home. For example, if the seller suddenly decides not to sell the home, they can’t just walk away with your earnest money payment. And if you decide not to follow through and purchase the home, you can’t just walk away with your money either. It provides a sense of security and protection for both the buyer and the seller.
Escrow and Your Lender
As we already discussed, escrow is not only used between the buyer and seller of a property—but also between the buyer and the lender. These financial transactions, such as those pertaining to tax and insurance payments, are made by the lender to your escrow account. The lender might also refer to terms such as “reserves” or “prepaid fees” when referring to financial transactions that are made into escrow during the purchase process. These are sometimes referred to assure that the escrow company and/or lender has enough cash to pay the necessary fees at the time in which they are due. Â
Your escrow account then pays them to the applicable parties at the correct intervals and at the appropriate times. This is because your lender has a vested financial interest in the payment of items such as property taxes and insurance premiums because if you were to forego paying either of them, liens could be placed on your property—and your lender still owns a good portion of your property as long as you are paying on your mortgage.
Closing of Escrow
Once your loan closes, your escrow account will as well. Your lender will then take on the responsibility of paying out your insurance premiums and tax payments, and anything else that might be charged alongside your monthly mortgage payment (typically just tax payments and homeowner’s insurance premiums).
At the time of closing, an escrow officer will manage the final paperwork associated with the transfer of funds and ensure every cent is properly disbursed to the correct parties. After the escrow account has been completed and emptied, your lender will take over making the extra payments to tax authorities and your insurance company with money you pay on your mortgage payment each month.
Ready to Buy?
Now that you’re equipped with some very important knowledge, if you’re ready to buy a home, call us toll-free at 1-877-480-8050 and get pre-qualified today. Our staff of friendly, knowledgeable Personal Mortgage Advisors will walk you through everything you need to know about buying a home—including any additional questions you might have regarding escrow.
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