You may have heard people exclaim, “We’re in escrow!” when buying or selling a house. But what is escrow, exactly? An escrow agreement is an arrangement in which a third party acts as an intermediary between two transacting parties. This third party is in charge of receiving and distributing the property and money.
But why is escrow important? And how can you keep costs low?
Let’s take a closer look at how escrow works in relation to a mortgage.
What is escrow on a house?
Escrow is a transitional step in the sale of a home. When a property is in escrow, its buyer and seller are approaching the close of the sale, but still need to work out the details.
During escrow, the buyer shows proof of approval for a mortgage loan and provides an earnest money check. The seller then takes the property off the market, provides access to the property for inspections, and performs required repairs or renovations. They may also offer a review of the title.
Once both parties are in agreement with the terms and conditions of the sale, escrow closes, the buyer pays, and the seller hands over the title.
What is an earnest money check?
If you want to buy a house, you’ll have to make an offer or sign a purchase agreement. At this time, you’ll typically give your escrow agent a deposit, usually for 1% to 3% of the final sale price. This payment is called an earnest money check. In return for your earnest money check, the seller will take the home off the market.
Why do you have to provide an earnest money check? Putting cash on the table demonstrates your seriousness to the property’s seller, and reduces the risk that you’ll back out on the deal.
Once you’ve made your deposit, the escrow agent places the check into a short-term escrow account. Neither buyer nor seller can access this account until the deal closes.
Once the sale of the house closes, the deposit in escrow goes toward the buyer’s closing costs and down payment. If the sale falls through, the seller will usually keep the deposit.
What is an escrow agreement in the context of real estate?
In real estate, escrow comes into play both during transactions and after they close.
Escrow during a real estate transaction
Escrow agents serve as a neutral third party in real estate transactions, monitoring and helping to fulfill the conditions of the agreement. Their duties may include:
- Hold the earnest money check.
- Ensure all parties meet the conditions of the agreement (e.g., safety inspections, repairs, property tax audits, etc.).
- Distribute money to other parties in the transaction (e.g., prepaid mortgage interest to lenders, commissions to real estate agents, escrow agent’s fee to themselves, recording fees to the county, etc.).
Escrow after the mortgage loan closes
After the transaction, mortgage lenders often open a long-term escrow account for property taxes and homeowners insurance payments. This account is kept active until the loan is repaid in full.
Borrowers must add enough money into the account to cover their bills. Then, the lender pays these bills on the borrower’s behalf. This helps to prevent late payments and liens. Lenders may require borrowers to prepay money into the escrow account at closing (e.g., one year of homeowners insurance).
Why is an escrow agreement important in a mortgage?
Escrow helps to protect the parties involved in real estate transactions, both during the purchase and after the deal closes.
During the transaction, it helps both buyers and sellers. Buyers can put down a deposit to secure their home, confident that the money will go toward their future down payment. Further, sellers can take their property off the market with the assurance that the buyer has skin in the game.
And after the transaction, an escrow arrangement protects the investments of the mortgage purchase lenders.
How much does escrow on a house cost?
The cost of escrow services on a home purchase typically ranges from 1% to 2% of the final selling price. The fee is included in a buyer’s closing costs and can be negotiated between buyer and seller. Note that the cost of escrow is separate from the buyer’s 1% to 3% earnest money check.
Also, the amount you need to put down for the earnest money check varies. This cost may be higher or lower depending on your escrow agent and your location. Plus, if there are other buyers competing for the property, that can raise the cost of the earnest money check.
The amount you pay into your escrow account for the duration of your loan depends on the cost of your property taxes and homeowners insurance. In most cases, you’ll initially pay a few months in advance of each. Then, you’ll pay 1/12th of the annual cost each month.
Find the best deal on your next home
If you are in the process of buying a home, escrow is part of the deal. You can keep your costs low by finding the mortgage loan that offers the most value. Rates, fees, and terms vary from one lender to the next. Take the reins by shopping around, comparing offers, and choosing the right one for you.
SuperMoney makes it easy. Browse leading mortgage purchase lenders, rates, features, and reviews in one place. Find the best deal on your next home today.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.