What is Escrow?
Escrow is just one element of real estate basics that you should be familiar with as you explore buying or selling a home.
To start with a basic definition, Moving.com defines escrow as a legal arrangement in which a third party temporarily holds large sums of money or property until a particular condition has been met. With real estate, escrow can be used when you are purchasing a home, but also for the life of a mortgage.
Typically, an escrow account is created for real estate transactions because it allows the buyer(s) to perform due diligence on a potential acquisition. This means that as the buyer, you are taking the proper legal and financial steps towards securing your home. The escrow account then works to assure the seller that you can confidently close on the purchase.
For a better idea of how an escrow account can be used, Investopedia gives the example of the sale of a house. If there are conditions attached to the selling of the home, such as the passing of an inspection, the buyer and seller may agree to use escrow. In this situation, the buyer deposits the payment amount for the house in the escrow account. The seller can then proceed with the sell, confident that the funds are available and ready within the account. Once the conditions are met (in this case a home inspection), the sale is satisfied, and the third party transfers the funds to the seller.
What are The Types of Escrow Accounts?
Although we have already given the example of escrow used for home buying, Rocket Mortgage identifies two primary ways in which escrow is used in real estate:
- Home buying
- Taxes and insurance
Escrow Accounts for Home Buying
When buying a home, usually your purchase agreement comes with a good faith deposit. For the safety of both the buyer and seller, an escrow account is usually created to hold the good faith deposit. This deposit essentially shows to the seller that you, the buyer, are serious about purchasing the home. If something happens that results in your contract falling through, the seller usually gets to keep the good faith deposit as compensation. However, if the sale is successful, your deposit is applied to your initial down payment. Essentially, the good faith deposit works similarly to a safety deposit, except instead of it being returned to the buyer, the money is applied to your payment on the home.
Escrow Accounts for Taxes and Insurance
Your lender may want you to establish an escrow account for taxes and insurance once you purchase your home. This escrow account is created so that, after closing, your lender takes a portion of your monthly payment made to your mortgage and holds it in the account. Once tax and insurance payments are due, the money within the escrow account is used. Since your tax bill and insurance prices can change from year to year, your lender (or mortgage servicer) will adjust your escrow amount, this way, your taxes, and insurance are being paid fully and on time.
Do You Really Need an Escrow Account?
While it is entirely possible to pay for property taxes and insurance without the aid of an escrow account, you will have to save for tax and insurance payments on your own. This will lower your monthly mortgage payment, but taxes and insurance payments will come directly from your pocket.
So, while escrow is not required in your home buying and selling journey, its benefits for both buyers and sellers make it worth the extra time and steps. Real estate transactions are major, so the more protections you have in place (such as with the good faith agreement), the better the experience for everyone involved.
Before you begin considering opening an escrow account, there are a number of other elements you should take into consideration to know if you are ready to own a home.
Our experts here at Holland Homes are passionate about assisting you to reach your next phase of life, whether that be home buying or selling. With years of experience, our team is ready to partner with you today. Contact us to learn more about how we can support you best throughout the home buying and selling process!