Buying a home is a rewarding experience, but it can also be stressful. From saving for your down payment to choosing your ideal location, there are many steps to take when purchasing a home. But out of all the moving parts in the process, escrow is often one of the more confusing aspects for homebuyers.
When purchasing a home, being in escrow represents the time between a seller accepting an offer and a buyer obtaining the keys to their new property. If you’re not sure how to prepare or what to expect while in escrow, this guide will walk you through the basics that are important to know.
What Is Escrow and How Does It Work?
After reaching a purchase agreement with a seller, your real estate agent will typically collect your earnest money. This is different than the down payment and is a good faith deposit that shows you’re serious about purchasing a property. Your earnest money deposit is usually 1-3% of the home’s sale price. However, these funds do not directly go to the home seller. Instead, the funds are placed into an account with an escrow agent.
An escrow agent is a neutral third party that collects and distributes valuables (such as funds, financial documents, and deeds) on behalf of two agreeing parties until predetermined conditions are met. In real estate, escrow protects both buyers and sellers from fraud or nonpayment issues.
Mortgage lenders may also use these accounts to collect monthly payments for your property taxes and insurance after closing on a home. These are known as mortgage escrow accounts and are typically required for buyers with a down payment of less than 20%.
What Does “In Escrow” Mean
You’ve likely heard the phrase “in escrow” throughout your homebuying process. If you’re in escrow, this means that an escrow account has been created, and all required valuables (earnest money, deed, etc.) are with the agent.
When in escrow, the escrow agent will oversee that all parties receive what they’re owed. Once all conditions of a sale are met, the escrow closing process may begin. During this time, all funds and documents are distributed to the relevant parties. This includes sending the deed to the county’s recorder’s office to officiate the sale.
After closing, you’ll need to settle any escrow fees. Because escrow benefits both the buyer and seller, this fee can often be negotiated and split between both parties. Generally, most escrow services for a home purchase will cost around 1% to 2% of a home’s final price. Using national median home values, this translates to a fee of roughly $4,000 to $8,000.
Once escrow is closed, you can use your earnest deposit towards your down payment or additional closing costs.
Using an Escrow Account for Property Taxes and Insurance
After finalizing the sale, your lender may set up a mortgage escrow account to help pay for your property taxes, homeowners insurance, and private mortgage insurance (PMI).
Although these tend to be annual costs, lenders prefer you to pay a fraction of the total each month to ensure you don’t fall behind. Because of this, you’ll likely need to maintain a specific balance in your account. Generally, lenders will ask for a minimum of two months’ worth of mortgage expenses.
Why are lenders interested in your property taxes and insurance? During a foreclosure, any unpaid taxes or insurance could result in liens against a property, making it difficult for lenders to recover the original loan amount.
Keeping Your New Home Protected
Purchasing a home is not only an exciting time, but it’s also one of life’s most significant investments. To protect your home and family, it’s important to have a proper homeowners insurance policy.
A homeowners policy protects your property against life’s what-ifs, such as what if a branch falls on your home? In such cases, your policy will cover the cost to repair any structural damage—minus your deductible and up to your policy’s limits.
The information in this article is obtained from various sources and is offered for educational purposes. Furthermore, it should not replace manuals or instructions provided by the manufacturer or the advice of a qualified professional. No warranty or appropriateness for a specific purpose is expressed or implied.