What Is Escrow In Real Estate

When you buy your first home, it is essential to familiarize yourself with some of the unique terms you will find mentioned when dealing with your real estate agent. Escrow is one of them.

When you first enter the real estate market, you will realize that it is all about trust. How can you trust the other person? This is where escrow comes in. One of the requirements when purchasing a house is having what's called earnest money. Your earnest money deposit could be considered the glue in a real estate transaction. These monies are potentially at risk of loss if a buyer does not fulfill their obligations under the terms of the contract.

Earnest funds are essentially insurance for the seller that a buyer is not just going to walk from the transaction for no reason. Buyers can lose their earnest money if they are not careful. The earnest funds are typically held in an escrow account by the seller's real estate agent.

These escrow funds are typically anywhere between one to five percent of the purchase price. So if you are buying a $500,000 home, losing anywhere from $5000 to $25,000 is substantial.

Escrow In a Nutshell

Escrow is a necessary element of real estate transactions and other financial transactions. It means you enlist a third person to look after funds until the deal has been completed. The idea behind escrow is to create trust. After all, when it comes to real estate, you often hand over rather large sums of money. Needless to say, you want to know they are "safe" if things don't go according to plan.

Why Use An Escrow Account?

There are many good reasons to use an escrow account. They apply to many different types of industries and are used in both the commercial and private sectors. In real estate, the earnest payment is almost always deposited into an escrow account. It is held "in escrow" until the purchase has been completed. If a seller suggests you should pay the earnest payment directly to him, you should always say no.

Real Estate companies generally are the ones to hold escrow funds; however, on occasion, the seller's attorney or title company could also be in charge of the escrow.

Can I Access my Escrow Funds?

The funds held in an escrow account are subject to contract. This contract protects the seller as well as the buyer. The idea is to create trust and understanding between the two parties. For instance, you may want to inspect the property for a final time before the purchase is completed.

Lots of folks want to see the property again before moving in, and in fact, it's now customary to do so. Let me give you an example. If the home inspection turned up a few problems, and the current homeowner agreed to fix them, you want to make sure they have been corrected. Not only do you want to make sure they are all set, your lender probably wants to find out if these problems have been resolved.

Once everything has been signed off, the funds held in the escrow account will be released to the seller, and you can move in.

Other Types of Escrow Accounts

There are also different types of escrow accounts in the real estate industry. Another example is your mortgage company requiring escrow for certain things. Once you have bought your home, you may find your lender sets up an escrow account to cover for any expenses.

Not all homeowners take out the necessary insurances and pay their bills, such as taxes, on time. To cover these kinds of expenses, your lender may ask you to make escrow payments. 

The lender receives your monthly payment and then places part of it into an escrow account. When your tax bill is due, they will pay the statement using the escrow funds in the account. It is a great way to ensure your bills are paid, especially if you are a first-time buyer.

When your lender does not set up an escrow account for you, you need to make sure you budget to pay for insurances and taxes yourself.

There are probably more escrow account transactions in the United States than anywhere else, given specific banking requirements.

Online Escrow Accounts

There are other reasons to use an escrow account. If you do a lot of business abroad, for instance buying classic cars from a foreign country, you probably use escrow funds. The seller overseas is then obliged to make sure your purchase complies with specific rules and regulations and is shipped to you in a "good" condition. If the right documentation is not presented, the escrow funds will not be released to the buyer.

This kind of escrow is now more common as we tend to make higher-value financial transactions across borders. Once again, it shows how escrow protects both the buyer and seller.

Do you receive interest on escrow funds?

You don't usually receive interest on funds held in an escrow account unless funds are held for a very long time. That mainly applies to commercial transactions and not to real estate purchases. Escrow is perfectly safe, and there is no reason why you should have to worry about making a payment into an escrow account.

Escrow funds keep both parties accountable in a transaction, especially when it comes to real estate. Hopefully, you now have a better understanding of what escrow means in a purchase contract.