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What Is Escrow & How Does It Work?

October 27, 2020 · 5 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

What Is Escrow & How Does It Work?

Buying a house can be a lot of work. Before you even start looking at houses, there’s figuring out how much you can possibly afford.

Then, it’s saving for a down payment. Finally, after months of research, plenty of meetings with your real estate agent, and weekends spent driving from open house to open house, you’ve found your perfect fit.
It has an airy kitchen that gets great light, room for the kids (or dogs) to play, and a shaded patio perfect for entertaining. Oh, and that cozy reading nook you’ve always wanted.

You’ve done your research so you know that securing a mortgage loan and getting your offer accepted are just the first steps. You still have things like the appraisal, housing inspection and closing process to get through.
You may be familiar with the term escrow. If not, you may be wondering what does escrow mean?

What is Escrow?

At its simplest, escrow is when something of value, (in this example the transferring and financing of real estate), such as money or important documents, are held by a trusted and impartial third party until an event or condition takes place according to written instructions from all interested parties.

When it comes to the sale of a house, there are a couple types of escrow that may apply. The first type of escrow takes place throughout the home buying process until the sale is finalized.

The second type of escrow can be utilized when you are making mortgage payments to the lender on a loan that includes taxes and insurance (this type of escrow account is also known as an impound account).

How Does Escrow Work During the Home Buying Process

After a seller accepts an offer on a home, the selling agent opens escrow with the chosen escrow provider depositing the earnest money (deposit) from the buyer and a copy of the fully executed purchase contract laying out instructions and timeline for the transaction. The escrow process is designed to protect all involved parties, such as the buyer, seller, and lender, until the transaction is complete.

During the closing process, all the important documents and money will be held in escrow until the sale is final. For the buyer, this includes things like the earnest money deposit (EMD), which is a deposit made to show the seller that a buyer is committed to the sale.

The EMD, typically 1% to 2% of the total cost of the home, is verified by escrow and evidence is sent to the lender in writing. The deposit is then applied towards the down payment and/or closing costs.

Escrow is organized by an escrow agent or entity, depending on the state an entity could be someone from the real estate closing company or an attorney.

The escrow agent should remain an impartial third party throughout the escrow process and can only process the escrow in accordance with the escrow instructions. Typically this means they will execute instructions from parties, but won’t participate in any negotiations between the buyer, seller, or lender.

As the process moves forward, the escrow agent is responsible for things like ordering a title search from the chosen title company, tracking and verifying the items laid out in the escrow instructions for the home sale.
As each step is met, appropriate documentation is typically filed with the escrow agent and the appropriate parties are notified. Once the escrow instructions have been fulfilled, the sale can be completed.

The escrow officer can confirm with the lender that there are no clouds on the title,” which means that there are no outstanding claims from things like mechanics liens, tax liens, property line disputes, etc. and the title can be transferred to the buyer. When all is said and done, the buyer will officially become the home’s new owner.

Closing the escrow process generally requires a hefty amount of paperwork, and the actual process varies by state. Both the buyer and seller play a pivotal role throughout the escrow process, so it’s helpful to read everything closely so you’re prepared as the process evolves.

Should you run into any questions, you may find your real estate agent or lender could be good resources.

What’s the Benefit of Escrow?

The process of buying a home can seem confusing enough on its own—when you add in the intricacies of the purchase process and settlement, that confusion can seem amplified. But having a neutral third party to handle the paperwork and transfer of funds can be beneficial for all sides of a real estate sale.

Think of it as a buffer between two parties with competing interests. Depending on the specific contracts negotiated, escrow provides a safe space to store vital information while the loose ends are tied up.

Escrow is a required process when you obtain financing, but it is used in cash sales as well. As a buyer, it can be comforting to know that all the transaction details are being coordinated and handled by the appropriate parties.

For example, if the seller is unable to fix certain items before the buyer needs to move in, the lender may choose to set up an escrow hold back. This is when the lender approves to holds some of the funds in escrow that the seller should have received until the specified repairs have been completed within a certain period of time.

As a seller, escrow provides a safeguard in the event anything goes wrong with the sale. For example, if the borrower backs out of the sale and breaks contract terms, the EMD may be forfeited by the buyer to the seller.

How Much Does Escrow Cost?

The total cost of escrow varies. Depending on the state, the escrow provider may charge a flat fee or possibly a percentage of the sale price of the home. There might be additional fees too.

Again, depending on where you live, the seller and buyer may split the escrow costs. For instance, there are two types of title insurance requested for a home purchase.

Owners title insurance (purchased one time when the home is bought) and lenders title insurance (renewed with each new loan obtained on said home). It is customary in some areas for the seller to pay for the owners portion of the title insurance. This is spelled out in the purchase contract.

In addition to escrow fees, there will likely be a variety of other fees and costs during the closing process. These could include title insurance or fees associated with grant deeds, which transfers the ownership of the property.

Escrow After the Sale of the House

Another form of escrow takes place after the sale, typically in the form of an escrow account. If the house was bought with a mortgage, based on the type of mortgage and loan terms, the mortgage lender may require an escrow account be established to pay for taxes and insurance, also known as an impound account, or the borrower may request that one be added to the loan.

An impound or escrow account is where it is collected in many cases both at closing and on a monthly basis to pay your property taxes and insurance. The lender will then pay those fees with the money in the escrow account on behalf of the borrower.

By factoring them into the mortgage and placing funds in an escrow account, the lender can make sure these taxes and insurance type fees are paid in a timely manner.

That may be why loans that are higher risk with lower down payments for example are sometimes required by the lender to establish an escrow or impound account. Depending on the state you live in, you may earn interest on the funds in the escrow account.

Ready to Buy? Consider a Mortgage With SoFi

Preparing for the home buying process? If so, a major item on the to-do list might be finding a mortgage lender. As you comparison shop, you could consider a SoFi mortgage.

With SoFi, you could qualify for a mortgage with a competitive rate with as little as 10% down. It takes just a couple of minutes to find out the rates you pre-qualify for.

Learn more about getting a mortgage with SoFi.

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