What Is Escrow?

Answering one of real estate's most common questions.

While it may seem fundamental, this is actually one of the most common questions that we get from clients and prospects who are thinking about buying property. “Escrow” is one of those terms that gets thrown around all the time, and used in a variety of different contexts. In this article, we’ll look at what the term actually means, how it applies to real estate, and all the different ways escrow will come into play throughout a real estate deal.

What actually is escrow??

In the most general sense, escrow is a legal concept describing the use of a third party, which holds an asset or funds on behalf of two other parties that are in the process of completing a transaction. The third party, known as an escrow provider or escrow holder, helps to make the transaction safer by protecting the assets of both the buyer and seller until all parties have met their obligations for the agreement. While escrow is common in real estate transactions, it can broadly apply to any transaction where assets will pass from one party to another.

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Escrow and Real Estate

There are two common ways that escrow will show up in a real estate context.

  • Purchase Escrow
    • An escrow which is managed by a third party company to facilitate a real estate sale.
  • Mortgage Escrow Account
    • An escrow account which is sometimes required by a lender for the purpose of collecting funds from the borrower for costs such as insurance and property taxes.

Purchase Escrow

When you purchase property, you will go through an escrow process. In this case, the escrow is created specifically to facilitate the sale of the property. It exists for a specified time period, and is closed when the sale is completed. Depending on your area, this role may be filled by an escrow company, a title company, or in some cases an attorney.

The primary function of escrow is to be a “central hub” for all of the money that moves during a transaction. They collect all the amounts such as the buyer’s deposit and down payment, and the lender’s funds into a neutral account. Then at the appropriate time, the escrow company will distribute money wherever it needs to go, such as broker commissions, title and loan fees, insurance premiums, credits, and the seller’s proceeds.

In addition to moving money around, escrow functions as a facilitator for the transaction. They manage aspects like the signing of loan docs, ensuring compliance with local requirements, pro-rating property taxes and insurance premiums, and the transfer of the grant deed. Escrow may also act as a “timekeeper” for the deal, tracking deadlines like contingency and closing dates, and ensuring that all parties are performing.

“Opening Escrow”

Typically, escrow is opened on a transaction when two parties have fully executed a purchase agreement. When an agent says “we’re opening escrow” or “we opened escrow today,” usually this means that their seller has accepted an offer and they have a signed contract.

Technically, escrow is opened once the escrow holder receives the fully signed contract as well as the buyer’s earnest money deposit. It is at this point that they will officially “open” the escrow account. The buyer’s deposit, also called a “good faith deposit,” is an amount (3% is standard in Southern California) that deposited at the start of the escrow period, for the purpose of showing that the buyer is serious and has some “skin in the game.” The buyer’s EMD will need to be received within a set amount of time (3 days is standard).

When the agent sends the signed purchase agreement to escrow, this contract becomes the blueprint for the transaction. The escrow holder will use the contract to create a set of Escrow Instructions, which contain all of the duties and responsibilities of each party, as well as the due dates.

Side note – who is escrow? The company that will serve as escrow holder is chosen either by the Buyer or by the Seller in the transaction. This term will be negotiated in the contract. In a Seller’s market or a case where there are multiple offers, the Buyer may give the Seller the option to choose the escrow company as a way to make their offer more competitive.

“In Escrow”

This is a phrase that you will see often… and if you’re trying to buy in today’s red-hot market, you might even dread hearing it! If an agent says that a listing is “in escrow,” this typically means that the buyer and the seller are locked into a fully signed and binding purchase agreement. Some other terms that an agent may use (which mean essentially the same thing) are:

  • In Contract
  • Under Contract
  • Pending

An escrow period can last anywhere from a few days up to 45 days or more. This will depend on the terms of the contract, as well as factors like whether the sale is all cash or if the buyer is obtaining a loan. With conventional financing, the standard escrow period will be 30 days or more. The lender will use this time to have the property appraised, and to go through their underwriting and approval process.

When a property is “in escrow,” it may be anywhere along in this process. If it is still early in the escrow, and the buyer still has contingencies in place, the seller may still be willing to accept a backup offer from another buyer.

“Closing Escrow”

Escrow will close when all contractual obligations have been completed by all parties. While a closing date will usually be written into the initial contract, this date may change during the course of the escrow.

Once the escrow holder has confirmed that all the boxes have been checked, the final step will be the executing the grant deed which officially transfers ownership of the property. Escrow will coordinate with the Seller to sign the grant deed, which will then be recorded with the County. Once Escrow receives confirmation of recording, they will close out the escrow account and disburse any remaining funds.

Mortgage Escrow

After you close on your home, your lender might set up an escrow account to pay for periodic expenses like property taxes and insurance. This can be optional, or it may be required by your lender. While the purchase escrow only lasts until the transaction is closed, this mortgage escrow account will be ongoing, either for the entire term of the loan or for a specified time (such as until a certain loan-to-value ratio is reached).

Because the mortgage-holder has a vested interest in the property, they want to make sure that their investment is protected. So it is in the lender’s best interest to make sure that payments are made on time for expenses like taxes and insurance. This ensures that these bills will never be paid late, to avoid lapses in insurance coverage or liens for unpaid taxes.

The borrower will typically have to fund this escrow account at closing. For example, the lender might require the borrower to pay upfront for the first year of property insurance, or for a few months of property tax (depending on when then next instalment is due). Then, the lender will calculate an amount which will get tacked onto the monthly mortgage payment, to ensure that there will always be enough in the account to pay for these expenses going forward.

Property taxes and insurance premiums are often billed at longer intervals (like yearly or every 6 months). So paying into an escrow account automatically with a monthly mortgage makes it much easier to keep track of these expenses and put money aside regularly, so that they don’t sneak up on you or get missed.

Quick Recap

Escrow is a common (and often required) aspect of the home buying and homeownership process. Its function is to protect both buyers and sellers during the purchase transaction, and to ensure that a borrower makes required payments like taxes and insurance on time.

Get in touch with us if you have any additional questions about the escrow process!

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