Updated June 28, 2019
If you’re looking to buy or sell a home, at some point, you will come across the word “escrow.”
The term escrow is used in many types of financial transactions, although most people's first escrow experience is through residential real estate.
At first glance, escrow accounts seem complicated but it's essential for home buyers and sellers alike to learn what an escrow account is, why an escrow account exists, and how it benefits all parties involved.
Don't think you have to go through the escrow process by yourself. By working with an experienced, local real estate agent, you'll have a guide through every step. And whether you're buying or selling, working with a Clever Partner Agent can save you money.
Escrow Accounts 101
An escrow account is a safe third-party account used for a specific, stated purpose. At its core, an escrow account is essentially a holding cell for safekeeping important documents or funds.
In a large transaction with multiple moving parts, everyone wants assurance that no money or property exchanges hands until completing every step. Buyers, sellers, and lenders can be confident everyone will do their part while the money and documents are secure with a neutral third party.
There are two types of escrow accounts related to real estate — real estate escrows and mortgage escrows.
How a Real Estate Escrow Account Works
When you're buying a new home or selling your old one, a real estate escrow account keeps sensitive paperwork and money safe and secure until the transfer of title from the seller to the buyer.
Some of the sensitive items held in the escrow account can include:
- Earnest money deposit
- Sales contracts
- Inspection reports
- Property deeds
Typically, the buyer’s and seller’s real estate agents will work with the bank to create an agreement that will be signed and delivered to the escrow officer. The escrow agent, usually a title company employee or lawyer, will process the escrow. While the escrow officer monitors the escrow account, the buyer and seller work out the details of the transaction. When all conditions required in the escrow are met, the escrow will "close" and the transaction officially takes place.
Real Estate Escrow Account FAQs
What does it mean when a house is in escrow?
Once a seller accepts a purchase price, the house begins the escrow process. During this time, which takes a month or two, specific documents have to be submitted and all of the contingencies and obligation of the purchase agreement have to be completed.
The escrow process is different from state to state, but in general buyers and sellers have to do the following:
- Pay the down payment and closing costs.
- Secure financing either through a mortgage loan or other option.
- Complete all requirements of their mortgage lender like buying private mortgage insurance.
- Purchasing title insurance.
- Have the home inspected and appraised.
- Make necessary repairs.
- Perform any obligations like taking the home off the market.
Once all these steps occur, the deal closes and the title of the home is transferred to the buyer
The deal falls through – what happens to the earnest money?
A real estate sale might not close for several different reasons. In fact, Trulia released a study that shows 3.9% of transactions failed in 2016.
Some more common causes include a buyer not qualifying for a mortgage or unknown issues with the property surfacing during the home inspection. When one of these events happen, the sale “falls out” of escrow. What then happens to the escrow funds varies based on several factors, such as who was “at fault” for the failure.
If a buyer withdraws from a sale without a good reason, the buyer’s earnest money may go to the seller. On the other hand, if the seller cancels the sale, the buyer’s funds will be returned. The coordination of how escrow funds are handled in each of the various situations are in the purchase agreement, a document which diligent buyers and sellers should read very carefully.
How Mortgage Escrow Works
A mortgage escrow exists primarily between the lender and the home buyer. When the home buyer secures a mortgage, the lender will usually require the buyer opens an escrow account, either through the lender or an escrow company.
After opening the account, the home buyer is usually required to make a deposit in advance as a financial cushion. This ensures there will always be enough in the escrow account to cover the estimated property taxes and insurance payments.
The lender will subsequently add the estimated taxes and mortgage insurance premiums to the principal of the loan. Since the property itself is collateral, the lender must ensure that the property is adequately insured with no risk of a tax lien being placed on the home.
After completing the home buying process, the new homeowner will pay escrow payments in addition to their monthly mortgage payment. When taxes and homeowners insurance premiums are due, the lender will access the extra funds in escrow to pay them.
Mortgage Escrow Account FAQs
What determines how much to withhold in a mortgage escrow?
The amount that goes into escrow varies annually based on tax assessments and insurance adjustments, both of which fluctuate. If the homeowner has not paid enough in escrow to pay the tax and insurance bills, the lender will often cover the shortage and adjust the homeowner's house payment to reimburse the cost.
If there is an overpayment into the escrow account, the homeowner may receive a refund. Some states require lenders to pay interest on escrow accounts, so checking with your lender regarding rates may be beneficial.
What does an escrow account pay for?
In general, a mortgage escrow account will pay for your yearly property taxes and insurance premiums — both homeowners insurance and private mortgage insurance (PMI). Once you've paid off enough of your home, your lender will allow you to drop PMI, lowering your escrow payments.
Is a mortgage escrow account required?
Whether an escrow account is mandatory depends on the financial institution lending the mortgage. Most lenders will require an escrow account if the borrower puts less than 20% down on the property.
Lenders that do not need an escrow account will often drive up the interest rate of the loan for added protection against the risk of loss. Since insurance premiums and tax payments are usually sizable bills to pay all at once, most homeowners find escrow accounts a convenient way to break these large payments into manageable pieces.
Home buyers should also be aware that, once an escrow is established, it can be challenging to dissolve. Most of the time, lenders require that the homeowner has at least 20% equity in the home before considering a cancellation request. If the homeowner cancels their escrow account, they are responsible for honoring all insurance and tax payment schedules.
Do you get escrow money back at closing?
When you sell your home, you'll pay off your mortgage. After transferring the title, you'll no longer be responsible for property taxes or insurance on that property. If there is still money left in your escrow account, it will be refunded by your mortgage lender.
How long does it take to get escrow money back after selling?
If your mortgage loan was in good standing when you sell your home, your lender typically has 20 days to give you and remaining escrow funds. If you go through a foreclosure or short sell your home, you might have to forfeit any money left in the account.
Escrow as a Safety Valve
Think of an escrow account as a safe place for buyers, sellers, and banks. Remember that there are two different types of escrow accounts used for separate purposes: one for your mortgage and the other for the real estate transaction. Escrow accounts protect all parties during one of the most significant and complex transactions of their lives.
If you need someone to help you through the escrow process, work with an experienced realtor you can trust. Clever connects home buyers and sellers with real estate agents in their area and who can answer your escrow account questions and more.
As a seller, you’ll receive their full services for a flat fee of $3,000 or 1% for homes over $350,000. If you are thinking of purchasing a home, working with a Partner Agent could qualify you for $1,000 Home Buyer Rebate (or up to 1% if the home is over $350,000) in states that allow.