Escrow is a big part of real estate transactions and protects buyers and sellers during the home purchase process. It also allows homeowners to easily pay their property taxes and insurance premiums.
Although it isn’t always required, there are several steps to the escrow process. Here’s what it means to be in escrow and how it can affect you as a buyer, seller, and homeowner.
What Is Escrow?
In real estate, there are typically two different types of escrow: one for when you purchase a home and another for when you pay your property taxes and insurance premiums.
When buying a home, escrow refers to a legal agreement where a third party (such as a closing company, attorney, or title agent) holds money or property “in escrow” until specific conditions in the contract have been met for the sale to close. These conditions normally include receiving an appraisal, title search, and financing. Once these conditions are met, funds are disbursed from the escrow account and escrow is closed.
After the transaction, funds can also be held in a mortgage escrow account. This is used by the mortgage servicer as a way to pay property taxes and insurance premiums, such as homeowners insurance and mortgage insurance. A mortgage escrow account won’t cover everything, like homeowners association (HOA) fees.
What Does “In Escrow” Mean?
“In escrow” means that all items in the escrow account (loan funds, earnest money, property) are held by the escrow agent until the terms within the arrangement have been satisfied. Items in escrow cannot be touched until both the buyer and seller meet these conditions.
How Does Escrow Work When Buying a House?
During the home sale, the purchase agreement may include a stipulation that requires the buyer to pay earnest money that will be held in an escrow account. These funds are held until closing, after which the money will be disbursed from the escrow account and go toward the buyer’s down payment or closing costs. If the contract is terminated, then the earnest money will go toward either the buyer or the seller, depending on the terms of the agreement.
After the transaction, there could also be a mortgage escrow account. This is set up and managed by the mortgage servicer and is used to pay your property taxes, homeowners insurance, and mortgage insurance (if applicable). The servicer takes part of your monthly mortgage payment to hold in the escrow account and makes your tax and insurance payments using these funds.
Because what you pay in taxes and insurance can change, your loan servicer determines your escrow payments for the year based on bills paid during the prior year. To make sure there’s enough in your escrow account to cover your bill, most loan servicers require at least two months’ worth of extra payments in your account.
The loan servicer will analyze the escrow account each year to determine whether they’ve collected the right amount to cover your bills. If they collected too much money, then you will receive an escrow refund. If not enough money was collected, then you will need to cover the difference.
Typically, there are two options to cover the shortage in the escrow account. You can make one large payment or pay a higher monthly escrow fee.
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How Does Escrow Work at Closing?
Three business days before closing, a closing disclosure is sent to the buyer by their mortgage lender with a final list of closing costs and escrow amounts. At closing, the escrow agent creates a document naming the buyer the new homeowner which must be filed with the local records office. Funds are then wired to the escrow account to pay the seller and seller’s lender.
How Much Does Escrow Cost?
Escrow fees are charged by the third party involved in the transaction and are included in the closing costs when you buy a home. Common escrow fees include:
- Real estate attorney
- Mortgage origination
- Property taxes and county fees
- Seller profits from the transaction
- Homeowners insurance premiums
- Title insurance premiums
On average, the escrow fee is 1% – 2% of the purchase price of the home, but this can vary. The escrow officer may also charge an additional fee for its services.
Who pays the escrow fees can be negotiated between the buyer and seller. In many cases, the escrow fee is split between both parties.
Is an Escrow Account Required?
Escrow accounts are required for many types of loans. However, in the event that you don’t need one you can still request to open an account or even qualify for an escrow waiver.
For conventional loans, you’ll need to make a down payment of 20% or more to opt out of an escrow account. VA loans require at least 10% down and a strong financial profile while FHA loans require all borrowers to have an escrow account. Even if you are not required to have an escrow account, you could also choose to open one voluntarily.
If you’re able to get an escrow waiver, you will need to save for and pay your taxes and insurance premiums separately. Instead of these bills being included in your monthly mortgage payment, you will need to pay in a lump sum when they’re due.
If you fail to keep up with your payments, then your lender may reverse the waiver and require you pay into an escrow account.
Explore Your Options With Total Mortgage
Escrow is an essential part of real estate transactions, but it isn’t always required. While it may seem like just another expense during the closing process, it protects both the buyer and seller and can offer homeowners an easy way to pay their taxes and insurance bills.
Looking to buy a home? Check out Total Mortgage’s loan program options when you’re ready to make an offer. If you have any questions, schedule a meeting with one of our mortgage experts.
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Source: totalmortgage.com