What Is Escrow & How Does It Work?

By Jody McMaster · December 15, 2022 · 5 minute read

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What Is Escrow & How Does It Work?

Escrow isn’t the most euphonious word, but it’s important when you’re a homebuyer or homeowner.

With a home sale, escrow refers to a neutral third party that handles money and other assets being transferred between two parties. The escrow agent ensures that the terms of the deal are met by both sides.

What Is Escrow?

There are a couple of types of escrow. The first takes place throughout the homebuying process until the sale is finalized.

The second type of escrow applies when you are making mortgage payments that include taxes and insurance. An escrow account set up by the lender or mortgage servicer will accrue bits of your payments and pay the bills when they’re due.

First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.

How Does Escrow Work During the Homebuying Process?

After a seller accepts an offer on a home, the buyer’s or seller’s agent opens escrow with an escrow provider, typically a title company.

Money and the purchase agreement, seller’s deed, and other documents will be held in escrow until the sale is final.

This includes the homebuyer’s earnest money, or good-faith, deposit, which shows the seller that the buyer is earnest — committed to the deal.

The earnest money deposit, typically 1% to 2% of the purchase price, though it can be more in a hot market, is verified by the escrow agent, and evidence is sent to the lender in writing. The deposit is held for use toward the down payment and closing costs.

Buyers who minimize contingencies risk losing their earnest money deposit.

Common contingencies include the mortgage contingency, which allows either party to walk away from the deal if the buyers are unable to secure financing by the agreed-upon deadline, and sale of current home contingency, when buyers need the proceeds from the sale of their existing home to afford the new home.

Others are appraisal and home inspection contingencies.

As the process moves forward, the escrow agent is responsible for ordering a title search, and tracking and verifying the items laid out in the escrow instructions for the home sale.

What’s the Benefit of Escrow?

Escrow is designed to protect the buyer, seller, and lender until the transaction is complete. Having a neutral third party handle the paperwork and transfer of funds can benefit all parties in a real estate sale.

Escrow is required 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 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 holdback: The lender approves holding some of the money 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 if anything goes wrong with the sale. For example, if the borrower backs out of the sale and breaks terms of the contract, the earnest money deposit may be forfeited by the buyer.

Recommended: Selling a House With a Mortgage

How Much Does Escrow Cost?

Escrow companies usually charge a base fee plus a percentage of the purchase price. That typically comes to 1% to 2% of a home’s sale price, but the cost varies by state and county.

For a $400,000 house, an escrow charge of 2% would be $8,000.

You may want to ask your real estate agent to recommend a title company with low rates.

In many states, the buyer and seller split escrow fees or negotiate how they will be divided. The market temperature — buyer’s or seller’s market? — can affect the negotiation.

Escrow After the Sale of the House

If you put less than 20% down on a conventional loan or take out a government-backed loan, your lender will typically establish an escrow account at closing with money to pay homeowner’s insurance, property taxes, and, if necessary, private mortgage insurance (commonly called PMI) and flood insurance.

Once established, the account is maintained by monthly contributions from your mortgage payment. When taxes and insurance are due, the lender or servicer pays them.

The escrow amount will be reflected on your mortgage statements.

Recommended: What Is PMI and How to Avoid It?

The Takeaway

What is escrow? It’s the holding of money and documents by an impartial third party during a home sale, after which a homebuyer escrow account usually is set up. Escrow during a sale protects the buyer, seller, and lender.

If you’re in the market for a home and financing, check out SoFi’s menu of mortgage loans and deals being offered.

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What is an escrow balance?

The escrow balance is the money that is held in a mortgagor’s escrow account to pay taxes, insurance, and, if applicable, private mortgage insurance and flood insurance.

What is an escrow agreement?

An escrow agreement is a contract that outlines the terms and conditions of a transaction for something of value, which a third party holds until all conditions have been met.

What does it mean to be in escrow?

It means that an escrow agent is holding the earnest money, loan funds, and property deed until an appraisal and title search are done and financing has been approved. The earnest money typically will be applied to the down payment or closing costs.

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