What is "Escrow" in Real Estate?
At Unreal Estate, we believe in simplifying the complex and being fully transparent about all things real estate. It is why we’re breaking down real estate expressions, so that you can take control of buying or selling your property. While the term “escrow” is commonly talked about in the industry, understanding it can be a bit of a mystery. Therefore, we are going to dive into the topic so that you can learn about escrow’s role in the process of buying or selling a home.
Escrow is an account set up to protect both the buyer and seller during a real estate transaction. It's essentially a way to hold onto funds, such as the good faith deposit or earnest money, until all conditions of the sale have been met. This helps to ensure that both parties are protected in the event that something goes wrong with the deal.
There are actually two types of escrow that you might encounter during a real estate transaction. The first is the escrow account that is set up during the home buying process. This holds onto funds such as earnest money until closing. The second type of escrow is set up after the home buying process is complete. This escrow account is used to hold onto money meant for paying property taxes and homeowners insurance on time each year. The servicer, or the company responsible for managing this second type of escrow, will analyze it annually to make sure the right amount of money is collected. If they have collected too much, you may be eligible for an escrow refund. If they haven't collected enough, you may need to cover any payment shortages that exist when the account is analyzed. In some cases, you may have the option to make a one-time payment to cover any shortages instead of having to pay more each month.
When you're in the process of buying a home, you'll likely be required to make a good faith deposit, also known as earnest money, to show your commitment to the purchase. This money is typically held in an escrow account until the closing of the sale. In some cases, there may be funds held in escrow past the completion of the sale, known as escrow holdbacks. These holdbacks are typically used for a specific purpose, such as allowing the seller to stay in the home for an extra month or to make necessary repairs before closing.
Once the home buying process is complete, the lender will take over the management of a third type of escrow account. As part of your monthly mortgage payment, a portion of the money will go into the escrow account to pay for property taxes and homeowners insurance. This helps to ensure that these payments are made on time each year, which is important for maintaining the integrity of your home and your credit score.
First and foremost, escrow protects the interests of both buyers and sellers. For buyers, knowing that their good faith deposit is being held securely in an escrow account can provide peace of mind and reduce the risk of losing your deposit. For sellers, having an escrow account gives them confidence by protecting them in the event that something goes wrong with the deal. It ensures that both parties are held accountable for meeting the terms of the agreement, which can make the process of buying or selling a home feel a little more secure.
To sum it up, escrow is a necessary process in real estate transactions that helps to reassure both buyers and sellers that everything is handled properly. It's important to understand the role that escrow plays in the process and be aware of the options available to you if an annual analysis finds a shortfall in payments. With a better understanding of escrow, you can minimize doubt and feel secure in trusting the real estate journey.
Escrow holds funds in a secure way by a trusted third party.
The first type of escrow holds good faith (or earnest fund) deposits on transaction contracts.
The second type of escrow holds contracted or negotiated funds often paid at, or after, closing.
The third type of escrow holds the mortgage companies property tax and insurance.
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