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Escrow: What It Is And How It Works

Erica Gellerman4-Minute Read
May 12, 2020

You’ve decided to buy a home and you’ve had an offer accepted on your dream home. But just because a purchase agreement has been signed doesn’t mean it’s yours yet. There are likely contingencies or contractual obligations that must be met before the keys are handed over. This process can be referred to as escrow and can help make the process of finalizing this big purchase much smoother.

Escrow, Defined

Escrow is the withholding of money by a neutral third party until a transaction can be finalized.

If you’re making a large purchase, it’s hard to trust a seller you’ve never met before. An escrow provider will work as an intermediary – they collect the money and hold it, only releasing it to the seller when both you and the seller agree.

Using escrow for a purchase helps to make transactions safer. Escrow can be used in a number of different situations including:

  • Online purchases: If you make a large purchase online and want to withhold paying until you actually receive the item, you’d likely use an escrow account to help with that. The buyer deposits money into an escrow account. Once both the buyer and seller are satisfied, the funds will be disbursed from the escrow account.
  • Home buying: When a buyer makes an offer on a home and it’s accepted, they usually deposit earnest money into an escrow account to be held until the sale is finalized or is canceled.
  • Ongoing payments: Large, irregular payments, like property taxes and insurance, are generally paid through an escrow account set up with a mortgage servicer. The property owner pays into the escrow account monthly and the mortgage servicer is responsible for settling the payments when they come due.

How Escrow Works In Real Estate

Once an offer on a home has been accepted, you’ll hear that the house is now “in escrow.” What does that mean?

The seller wants to know that the buyer is actually serious about purchasing the home. In most cases, the process to close on a home can be long. A buyer deposits earnest money into an escrow account as a show of good faith when making an offer to purchase a home. How much and where the earnest money will be held are outlined in the purchase contract.

The process of closing then continues as each of the contractual conditions/contingencies are met. For example, there may be a home inspection, an appraisal, title search and loan financing to secure before closing can be completed.

Once all conditions for the purchase have been completed, the escrow period will end, the earnest money is applied to the sales price, and the sale will close, or finish.

Escrow Accounts

When talking about escrow accounts in real estate, there are two main types of escrow. The first, described above, is used during the sale of a home. An escrow account can be used to hold the earnest money until a sale closes.

Once your home closes, there may be another escrow account that you use. This one is set up by your lender and used to pay expenses related to your property. When you make your monthly mortgage payments, a portion of them are diverted into an escrow account. This account is then used to pay your property tax and insurance bills. Rather than paying a big bill all at once, putting money into an escrow account ensures you’re setting money aside monthly to pay them. Your mortgage servicer will use the money in the account to pay your bills.

Many lenders require that you pay your property taxes and insurance payments using an escrow account. If you don’t use an escrow account and you don’t pay your property taxes, the government could impose penalties, place a tax lien on your home, or even foreclose on it.

Benefits Of Escrow

During the home buying process, an escrow account is beneficial as it shows a seller that a buyer is really motivated and serious when they’re making their offer. An escrow account can also hold both the buyer and seller accountable to the terms of the agreement.

Once you’ve purchased a home, an escrow account can make it easier and more convenient to make property tax and insurance payments. Because these can be big bills, saving for them monthly in an escrow account makes budgeting easier. It’s also helpful because there’s no need to remember when these bills are due – your mortgage services will take care of making the payment for you.

How To Choose An Escrow Company

You typically won’t find the real estate agents handling the escrow money – neither the buyer’s agent nor the seller’s agent – to help avoid bias.

You’ll generally have the option to use an attorney, a title insurance company, or a designated escrow company to manage the escrow.

The buyer is generally in charge of deciding who to use for escrow, though the seller can disagree and offer their own suggestion. When choosing an escrow agent, considerations include the experience of the escrow officer, the financial stability of the escrow company, and the price of the escrow services. If an agent has successfully worked with a particular servicer in the past, they might recommend that person or company.

The Bottom Line

There are a lot of details to learn when you’re buying a home, including understanding the role an escrow account plays in the process. If you’re just starting your home buying journey, you may want to contact a Rocket HomesSM Partner Agent to help you find the property of your dreams.

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Erica Gellerman

Erica Gellerman is a CPA, MBA, personal finance writer, and founder of The Worth Project. Her work has been featured on Forbes, Money, Business Insider, The Everygirl, The Everymom and more.