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What Is Escrow in Real Estate?

by Point2 Staff
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4 min. read

Escrow is a term you’ll likely hear when buying or selling property. While it’s not limited to real estate, it’s an important term to understand if you’re planning a real estate transaction. With that in mind, let’s look at what escrow is and how it works.

Just What Is Escrow?

Escrow refers to a neutral, trustworthy, third-party holding account in which both the seller and the buyer can place cash, assets and documents during a real estate transaction. The most common assets that are placed into escrow when buying or selling a home are:

  • The down payment
  • The earnest money deposit
  • Property deeds
  • Title checks

These are then held in the account until a set of terms and conditions are met. Generally, these are detailed in the conditional offer and may relate to a favorable home inspection, the go-ahead for taking out a mortgage and clear title checks.

Aside from property transactions, there is another type of escrow you may come across in real estate, which relates to the lender. This will generally come into action once mortgage payments start for a homebuyer. In this account, monthly payments covering property tax and insurance will be stored throughout the year before being paid off by the lender when the year is out.

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Is Escrow Really Necessary?

It’s not usually a legal requirement to use an escrow service when buying or selling a home. However, since a real estate transaction is rarely as straightforward as sending the seller the agreed amount of money and getting the deeds in return, using escrow is strongly recommended. In some cases, lenders will insist on it, but even if not, an escrow account will protect all the parties involved.

An escrow account lets the buyer show the seller they’re serious about the purchase. But, by paying the earnest money deposit or down payment into escrow rather than to the seller directly, the buyer can be sure that if the sale falls through, they’ll have no trouble getting their money back. Once in the escrow account, any money, deeds, paperwork and title checks are safe and secure.

With a lot of time, money and effort on the line, it’s essential to know that you’re protected, whether you’re the buyer, seller, or even the lender.

How Does an Escrow Account Work?

The opening of the escrow process begins when the buyer has made an offer on a home, and the seller has accepted. Together, the buyer and seller, often with assistance from their real estate agents, will choose a trustworthy escrow service to use. Once selected, the account is typically opened when the buyer places their earnest money deposit into it.

Next, both parties will list the conditions that need to be met for the contents of the account to be released. This will then be written down in a legally binding agreement. After that, each party adds its various obligations into the escrow account until all the conditions are met. The buyer will generally add the down payment and any other financing, while the seller is usually required to input the deeds, as well as documents proving a passed home inspection and clear title checks. However, the exact items will differ depending on your agreement.

Once all the obligations are added to the account, the escrow agent will double-check everything. If satisfied, they will release the contents to the appropriate parties, a process known as the closing of escrow.

How Much Does an Escrow Service Cost?

This service does come at a cost, though many will agree that the security it offers makes it a price worth paying. Escrow fees are typically included among the closing costs and are, on average, between 1 and 2% of the home’s sale value. Usually, these fees are split between the buyer and seller, though either party can negotiate this aspect.

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