What is Escrow? How Does it Protect You?

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What is Escrow? How Does it Protect You?

It is no secret buying a home is a big purchase. In a transaction so significant, how are you supposed to trust the other person – especially when you’re not likely to meet them? The short answer is: escrow.

 

What is Escrow?

Escrow is a risk minimizer. It is an arrangement in which a third party, who is neither buying or selling, holds something of value. (Typically, this ‘something of value’ is money.)

The third party holds the escrow until both the buyer and seller have met a set of pre-agreed obligations. This helps protect all those involved, so that neither party could simply walk away from the transaction.

In most instances, the escrow provider is a neutral third party – someone who doesn’t have a vested interest in seeing the buyer or seller profit. The escrow provider’s job is like that of a referee – they make sure everyone sticks to the rules.

 

How Does Escrow Protect You?

In the simplest of terms, the rules surrounding escrow are clear-cut: A buyer agrees to pay a pre-agreed amount by a specific time. A seller agrees to the transfer of ownership.

Yet, buyers and sellers may introduce additional requirements, such as:

  • Formal inspection of the property
  • Specific maintenance and repairs
  • Extended use of the property after the sale
  • Specific items to be included with the sale of the house (such as the garage refrigerator, hot tub and/or bookcase)

In order to make sure your escrow ‘referee’ is fair and accurate, it is essential you work with a trusted escrow provider.

 

Are There Different Kinds of Escrow?

There are three different ways the term ‘escrow’ is used in relation to real estate. Most often, escrow refers to a third-party that holds a buyer’s earnest money. (Earnest money is a deposit made to show your commitment to the purchase. It’s typically 1% – 3% of the purchase price.)

However, escrow can also refer to the separate third-party account which holds a buyer’s homeowner’s insurance premiums and property taxes. This account is very similar to the escrow account which holds your earnest money – in that you put money in it and it provides protection. In this case, it’s protection for you and your lender.

With most home loans, your monthly mortgage payment doesn’t just cover the cost of your home loan. The monthly payment often includes expenses like your homeowner’s insurance and property taxes.

Homeowner’s insurance protects you in the event of a natural disaster, such as a fire or a flood. Paying your property taxes ensures the local government doesn’t place a lien on your home. (If a lien is placed on your home, the individual or institution who placed the lien collects the due sum when your home sells or is foreclosed.)

Each year, when your insurance and tax bills are due, your lender pays these bills for you with the money in your escrow account – simplifying the process for you and protecting both your interests.

The final use of the term ‘escrow’ refers to the closing of an escrow account. During this process, the escrow officer meticulously reviews each document, ensuring both the buyer and seller have met their obligations. The escrow officer (aka closing agent) also ensures the sale is recorded with local government to formalize the sale.

 

Is Escrow Only for Home Buyers?

Nope! Escrow services can also be used for online sales – a transaction that is particularly risky. Because online sales can be conducted with individuals throughout the world, making sure both parties hold up their end of the deal can be difficult.

Using a third party to manage an escrow account can allow for peace of mind. As with the home buying process, the buyer and seller would agree to a set of terms. The escrow agent would then make sure the terms were met before the funds (or assets) were released.

 

What Does it Mean to be ‘In Escrow’?

As much as you would like to find the ideal house, make an offer and move in immediately – there are a lot of steps that must be taken before you get the keys. When you are ‘in escrow’, it means your documents are still being processed.

Depending on your lender, real estate agent, and escrow service, this process typically takes between 30 and 60 days. While you’re in escrow, you’ll want to avoid making any other major purchases or changes to your spending habits. Major purchases can affect your debt-to-income ratio (DTI), which could disqualify you for your loan – causing the deal to fall through.

 

Have additional questions about what escrow is? Contact a Fairway Kirkland loan officer.

 

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