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What Is Escrow? The (Ultimate) Guide | Real Estate Skills

When going through the process of buying a house you might find yourself having to go through escrow. So, the big question everyone seems to be wondering is what exactly is escrow?

The concept of escrow can be a confusing topic to get a firm grasp on. But, it is a very important concept to understand and learn. That's why we will break down everything you need to know about it in the article below!

Read on and enjoy What Is Escrow: The Ultimate Guide! Use this menu to jump to your section of choice: 

 

What Is Escrow?

The idea of escrow is one of the most important financial concepts to understand when buying or selling a house, and with any type of transaction that has to deal with two parties that need to hold money before a deal is closed. 

Escrow has to do with a certain amount of money being held by a third party for two independent parties until the agreement of a contract is finalized, such as when the purchase of the house is completed.

During the transaction, either of the two parties can make or break the deal so completion is held until the end. In order for the deal to go through, both parties need to accept and fulfill the contractual agreement proposed. 

Here is a quick overview of what exactly escrow is:

 

Is There More Than One Escrow Definition?

To get straight to the point, yes there is more than one escrow definition. The definition itself doesn't really change, but the areas it can be used in do.

Some might think only of real estate when hearing of escrow, when in reality it’s used in multiple areas of business. 

Here are some of the areas escrow is used besides in real estate transactions:

  • Internet Commerce
    • A third party is used to hold a certain amount of cash when dealing with internet auctions and commerce. This is to ensure safety for both transaction parties.
  • Banking 
    • This form of escrow has the majority of people using every day and that is an ATM when you make a deposit.
  • Intellectual Property 
    • This has to deal with the source code of software instead of money. They use third party trust accounts to hold the code as a safety net.
  • Mergers and Acquisitions 
    • This is where the transactions of companies ownership come into play. This is a long process, unlike others where it's a simple transfer of an asset.

Again, these are escrow definitions that people normally might not think of. That's why it's good to understand the different meanings of escrow that can be used outside of real estate!

 

What Is Escrow In Real Estate?

Escrow in real estate, as stated earlier, is when a third party holds the cash of two independent parties (buyer and seller) as earnest money until the contractual agreement of a property is fulfilled. 

In the process of buying a home, it is used to protect both buyers and sellers. This ensures the seller that the buyer has the money to go through with the purchase. It also protects home buyers from getting scammed and losing large sums of cash. 

In order for this process to go through without a problem, the parties focus on the fulfillment of the purchase contract, the transfer of the buyer’s purchase money, prorated property taxes, and completion of required disclosures among other tasks. 

Escrow also ensures a clean and clear transfer of title. This is to protect the new homeowner from having to deal with problems such as the title of the house having any liens on it.  

When going through the process, there are countless items of paperwork you'll have placed in front of you. That's why good communication with your escrow agent and company is key!

Here are some examples of the paperwork you might see in escrow:

Again these are just some of the most important items you may see. That's why it is important to have open communication among all parties to ensure everything is there.

Important Note! - Each state has its own specific escrow paperwork, so when looking into it make sure you include your state in your search!

Now you might start to wonder to yourself how long can these services really take in order to complete?

The duration can widely vary since every situation is different. Generally, a standard close of escrow on a house could take up to 30 to 60 days if everything were to go over smoothly. 

Since there is a lot of money involved and buying a house is not just handing the keys over to someone. In reality, it's much more than that. This is why it can take up 60 days to close escrow on a home!

Recommended Reading: How Long Does It Take To Close On A House?

 

What Is An Escrow Company?

An escrow company is a business that specializes in being a trusted third-party that has the ability to hold any given amount of funds securely. Along with them being able to hold those funds, they also assist in making sure the outcome of the escrow agreement is reached. 

They assign a trusted escrow agent or escrow officer to each case that is brought to their attention. This agent is the sole person handling all documentation involved and they have full trust of both buyer and seller. 

The officer is seen as an attorney for the escrow company they are working for. Here are some of the tasks they can assist in:

  1. Serving as a trusted third-party between two independent parties
  2. Keeping track of all expectations among the parties and making sure they are met
  3. Conduct a title search to see who is the current holder of the property
  4. Handling the funds such as; recording fees, real estate commission & loan payoff
  5. Recording the deed and any other closing documents involved
  6. Ability to close successfully between a buyer, seller, or lender
  7. Obtaining the title insurance policy

These are the main areas they can help, but there are many other aspects they can assist their clients with. Here are several examples of prominent escrow companies that can give you a better idea of what to look for in your particular real estate market:

 

Is An Escrow Agent Necessary?

Yes, an escrow agent is absolutely necessary! Hiring an escrow agent certainly has no harm to you or the other party you are doing business with. They are able to keep everything on record and on track instead of an ordinary person handling it that can result in confusion and future problems (lawsuits). 

It's always better to have that security blanket for yourself because you never really know who you are doing business with until the end. 

Since the closing process can take an average of 30 to 60 days with an escrow agent, you can only imagine how long it would take without one. Along with all that extra paperwork, it's better for someone who knows what they are doing instead of trying to complete everything yourself. 

The last thing that makes them absolutely necessary would have to be the high amounts of cash being put in the air while negotiations are being conducted. For instance, money deposited as an earnest money deposit and funds for the purchase price are sent directly to the escrow company, not to the buyer or seller.

They will provide safety for the money and ensure nothing will happen to it. The agent is your point of contact with the escrow company, so keeping in close touch with them makes sure the deal gets closed!

 

What Is An Escrow Account?

Here is a quick overview of what exactly an escrow account is:

An escrow account is where you set aside a certain amount of money from your monthly mortgage payments. 

The money you are setting aside is to cover your annual charges of homeowners insurance, private mortgage insurance (if necessary), property taxes, or any other insurances associated with owning your home. 

This is to ensure you as the homeowner that there will always be money set aside for these expenses. These payments are taken by your mortgage lender and they handle all of those bills themselves when they are due. 

Having this account makes your life easier as a homeowner because you're able to make predictable monthly payments instead of waiting for a large annual payment that's easy to forget about. 

You'd also have to make those payments yourself instead of letting your lender handle the majority of it. Since it isn't required for you to have an account, we HIGHLY recommend that you use escrow accounts to help manage your mortgages. 

Another benefit of opening an escrow account is that it could possibly lower your mortgage costs. This can happen when your lender offers a discount on your interest rate or closing costs because you're giving them that safety payment. 

This helps your lender have more confidence in you as a homeowner because they don't have to worry about you missing those payments. Just like when you skip a credit card payment, missing mortgage payments can ultimately hurt your credit, as well as impact the lender. 

So, save yourself from the hassle and uncertainty of being able to pay those inevitable property taxes and insurance premiums and open an escrow account!

 

What Does It Mean To Be In Escrow?

in escrow

When driving by a house with a for sale sign in the front yard you might see “In Escrow” on top of that sign and think that house is in process of being purchased. But in reality, the majority of people see that and wonder what in escrow means exactly. 

As we stated earlier, this process of being in escrow can take up to 30 to 60 days to complete and in that time frame properties are considered to be “Held In Escrow”.

Here is the explanation of what exactly goes on during this process:

Documentation Completion - This is where officers go over all the proper paperwork and ensure its authenticity. This ensures everything is done legally, properly, and that all agreements are met by both parties.

Physical Home Inspections - This is where all aspects of the house are checked by the buyer or a home inspector to ensure its function; such as heating, plumbing, electrical, etc. This also includes identifying any repairs that might be needed for the house. 

Appraisal - This is to ensure that the house is being sold for fair market value, not too high or too low. This is when banks are strict because they want to lend the right amount of money based on the appropriate loan to value ratio

Insurance - During the escrow process, proper homeowners insurance coverage is secured by the buyer. This is to protect someone from buying a home without adequate insurance, which can result in big financial problems later. Lenders may require it, as well. 

Title Search - This where a search of the property ownership and chain of title happens by checking all public records. The purpose of the title search is to clear any liens or clouds on title before it transfers to the new owner.

These are the most important things that are happening while a house is “In Escrow.” It's important to know how to prepare and what expect before deciding to buy or sell a house. Therefore, you can stay on track to avoid any issues or delays in completing each one of these items. 

 

What Does It Mean To Close Escrow?

close of escrow

If you made it this far in your process of buying a home, then congratulations you got the hardest part out of the way. You've 'closed escrow' on a home, meaning that the real estate transaction is complete and the home sale is final!

But just before you want to start celebrating with your new home, there are still some things that need to be done to fully complete the process. 

Closing escrow tends to happen on the last day of the contract when all the documents are prepared and ready to sign. This process of signing the documents can take up to 45 minutes to complete. 

After the documents are signed, they are then sent to the lender. Then, a real estate processor looks over the whole pile of papers to ensure no changes have been made. 

Then that's when the lender releases the funds to the title company. After that, the title company records the documents with the county. 

In order for the buyer to receive the keys, the county must record all documents. This can take a couple of extra days after you sign the documents officially. 

Important Note - Don't expect to have the keys on your specific closing date because it can take an extra couple of days to record the documents properly!

Also, if you're purchasing a house from a bank, then it is advised to close earlier than expected to avoid any complications that can prolong the process and make you miss your deadline. 

 

What Is An Escrow Officer?

what is escrow officer

Just like an escrow agent, escrow officers are neutral third parties that account for everything when dealing with two independent parties. They are simply your main point of contact with the escrow company. 

Officers do everything an agent does; they just have a different name. This happens because different states have different names for that specific job. 

Depending your state's laws, your escrow contact might be considered either an attorney or an officer. Hence, you just have to make sure you know which one you’re looking for in your specific area. 

When choosing an officer, real estate agents usually have local referrals that you can tap into. If you're an investor, you may want to seek out an investor friendly escrow officer or company that frequently works with investors and wholesalers

At the end of the day, using an officer is completely worth it because they can ensure the process of buying a home goes over smoothly!

 

What Is An Escrow Payment?

Escrow payments are regular monthly payments you make to your escrow account, which cover property tax and insurance premiums as they become due during home ownership. 

Property taxes and insurance are paid in full once a year, or can be spread out over multiple payments throughout the year. Instead of keeping track of these amounts and deadlines, many homeowners pay these expenses from escrow accounts. 

Since one annual payment for either of these expenses can be overwhelming to handle each year, home owners make smaller predictable monthly payments to fund their property's escrow account.

When taxes and insurance become due, they are paid for by the mortgage lender through the owner's escrow account. 

Making each scheduled payment is important so that you can pay your taxes and insurance bills when they become due. These payments dictate whether you find yourself in an escrow shortage, balance, or overage!

 

What Is An Escrow Shortage?

An escrow shortage is when you have insufficient funds in your escrow account. That means that you don't meet the minimum balance to afford payments for your taxes or insurance premiums. 

One of the reasons this can happen is when these expenses are expected to increase or they were more than you expected.

For example, if your taxes or homeowners insurance expenses go up over a course of a year, but all the escrow payments you made were based off a lower tax rate from a previous year, there will likely be a shortage.  

Therefore, if your expenses were to increase suddenly or unexpectedly, that will likely cause you to have a shortage.

When this happens, you may have to pay the difference in full. You may also have the option to pay over the next 12-month period through increased monthly escrow payments. 

Any adjustments in payments that occur at this time will pay for the shortage that already happened along with expected increases in property expenses. 

To get a better idea of what an escrow shortage is, here is a video going more in-depth:

 

What Is Escrow Balance?

what is escrow balance

An escrow balance is the amount of money present in your escrow account that has not yet been disbursed. That likely means you made all the escrow payments required and are on track to afford your property taxes and insurance premiums. 

Having an escrow balance doesn't necessarily mean you're safe forever or that what you paid is going to stay the same every year. Being able to consistently check on your account so you won’t be caught off guard with new charges will help you maintain a sufficient balance. 

Taxes and home insurance premiums may increase over time, and the escrow payments you're making are usually estimates for the coming year. So if these expenses were to increase, you might find yourself in a shortage, as we stated earlier. 

So, don't be shocked if you find yourself jumping around in having an escrow shortage, balance, or overage. These are more common than you would think!

The mortgage servicer will calculate the exact payments required based on the upcoming property tax bill and current insurance policy premiums. So, if you're out of balance, contact them and they can help you get back on track. 

 

What Are Escrow Fees?

When buying a home, there are a variety of escrow fees that are charged during the closing process. These expenses all have a meaning and you shouldn't necessarily think of them as up-charges. 

These fees make the process of buying a home much easier so at the end of the day they are worth it! 

Here are some of the fees you should expect:

Escrow Service Fee - This fee has to do with the agent or officer that is working with all the paperwork. These services tend to cost a few hundred to several thousand dollars, depending on the size of the transaction. These costs are usually split between the buyer and seller, but are always negotiable. 

 

How Can I Find An Escrow Company Near Me?

To find an escrow company near you, we recommend simply using Google search and typing in 'Best Escrow Company Near Me.' This will give you multiple options to look into and you can ask about their services and fees up front before committing to any one. 

Another way you can look into finding the best would have to be asking the people closest to you in the real estate business, such as a local real estate agent, broker, or property investment company. 

Personal referrals typically produce the best options. When someone is willing to recommend their services, they're usually a good choice. Networking in real estate is the best thing to do when trying to find the right people to get the best possible result. 

These are additional sites you can use to find an escrow company near you:

We gave three examples of great companies earlier in the article, so if you want to have a base of what to look for then those are good ones to reference!

 

How Can You Utilize A Mortgage Calculator With Escrow?

A mortgage calculator with escrow can be very beneficial for you when trying to understand your expected monthly mortgage payments. This will help you know the exact payment amounts you'll need to make every month in order to keep your home!

The calculator shows you your monthly payments, including principal, interest, property taxes, and insurance (collectively referred to as P.I.T.I.).

Using a mortgage calculator with escrow is an easy tool which will help you budget and plan when shopping for a home that you can afford with confidence. 

That's why using the Bankrate Mortgage Calculator is such a helpful resource.

To use it most effectively, you'll need to:

  1. Find out your expected mortgage interest rate by talking to a lender
  2. Figure out how much you are going to put down as a down payment
  3. Decide on your loan terms? 30 year fixed mortgage or 15 year adjustable rate mortgage?
  4. Get a quote for homeowner's insurance & any additional insurance required
  5. Look up the most recent property tax bill & determine a monthly figure

Plug all of this information into the calculator, and boom! You'll identify your approximate total monthly payment amount, including escrow payments.

Many people make the mistake of thinking principle and interest are the only amounts to budget for with their new home. Since you read this ultimate guide, you will fully utilize a mortgage calculator with escrow to learn the gross monthly expense to expect on your property. 

 

Final Thoughts

Understanding escrow is an important thing to do when trying to buy or sell a house. The only way to complete the transaction process of a home is to go through some form of it. 

This whole process can be very time consuming and confusing. So, getting a firm grasp of how everything works is critical. 

That's why it has been our goal to provide you with the ultimate guide to teach you all the necessary aspects to know when going through escrow. 

We hope that this article will not only further your knowledge, but will help make the closing process easier and prevent any issues from arising on your next real estate transaction!

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