If you've purchased a home, or currently are a home owner, you have probably heard of the term "escrow account." However, many homeowners aren't sure what escrow means or how it pertains to their monthly bills they pay. Landmark Home Warranty is going to explain the basics of what escrow means and why it's important for future and current homeowners to understand it.
Escrow Is Not Just For Real Estate
Strictly speaking, to have something in escrow doesn't necessarily have anything to do with real estate, even though the term is commonly found as part of a real estate transaction. At its core, escrow simply means to give something (usually money) to an impartial third party who will make sure conditions are met before that something (again, usually money) is given to the person for which it is intended. Ultimately, having something in escrow doesn't have to be about real estate at all, but more about having a middle person to protect two parties within a transaction.
When Escrow is Used in Real Estate
Although having something "in escrow" doesn't automatically mean it deals with real estate, the term is most often used in conjunction with real estate transactions. There are two main times in real estate when an escrow account is used:
Escrow Is Used in the Initial Purchase of a Home
Earnest Money Deposit
When you put an offer on a home, you usually include a check with 1-2% of the offer price to ensure the seller that you serious about wanting the home. This is called an earnest money deposit. Once you make an offer, and the offer is accepted, this earnest money deposit is cashed and placed into an escrow account, where it is held while the home is under contract.
The seller will receive the earnest money deposit from the escrow account if the buyer backs out of the contract for reasons that are not approved by the contract. The buyer will receive the earnest money deposit if the seller backs out of the contract for unapproved reasons or if they find something wrong with the home under the home inspection or disclosures and are uninterested in continuing with purchasing the house.
If everything goes well in the contract portion of the process, the buyer will deposit their down payment into the escrow account for the seller. The buyer can't take this money back and the seller also can't take this money until all of the conditions in the contract of sale are completed. This could mean that the seller can't take the money until repairs found during the home inspection are completed or the buyer is able to qualify for and obtain a mortgage, for example. The funds will be released to the seller after closing when the buyer and seller sign and approve financial statements, tax statements, and more. Once the escrow agent determines that everything is in order, the down payment funds will be released to the seller, along with the rest of the selling price, from the mortgage lender.
Part of the closing costs that a home buyer or seller pays are the escrow agent's fees to help them impartially negotiate the transaction. Neither the buyer nor the seller is strictly in charge of paying the fees so the escrow agent remains an impartial third-party to make sure everything gets done. Usually, their fee is approximately 1-2% of the sale price of a home.
Escrow Is Used or the Taxes and Insurance of a Home
Once the buyer becomes the homeowner, they have to pay home insurance and property taxes along with their mortgage payment. This is paid into one lump sum by the homeowner, but the mortgage lender actually separates out the money for the principle and interest on the mortgage and the taxes and insurance on the home. They place the taxes and insurance into an escrow account. Every year, the state or county will bill your mortgage lender for the property taxes on your account, and the home insurance company will bill the lender for your yearly insurance premium. The money that has been building up over the year will be paid from that escrow account to both parties. The next year, the process begins again.
Escrow Is Protection for Both Parties
When a transaction involves large amounts of money, it's a good idea to involve an escrow agent because it provides protection for both parties. Essentially, an escrow account is money purgatory. It can't be touched by either the buyer or the seller, and it also can't be touched by the homeowner,the insurance company, or the state. A buyer probably wouldn't want to pay a large sum of money to the buyer straight off before signing the deed to the house, just like a seller wouldn't want to sign over the deed to the home before getting paid. Having an escrow account makes sure all of the conditions of the sale contract are completed.
If you're looking at purchasing a home, or you currently own a home, make sure to look into protecting it with a home warranty. A home warranty, unlike home insurance, protects the systems and appliances inside of the home, like the HVAC, plumbing and electrical, as well as your oven, dishwasher, washer and dryer. You can get a free, personalized quote for your exact home, including different options for coverage by going to Landmark's home warranty quote page, here