Buying a house is a complicated process, so it’s refreshing when one simple concept covers more than one aspect of it. Escrow is just such a concept. This is the practice of enlisting a third party to hold both the deed to a property and the money used to buy it until both buyer and seller are satisfied with the terms. When this idea originated around the turn of the 20th century, selling property was much more simple. These days, having a neutral third party to make sure everyone is satisfied with the sale and purchase can give both buyer and seller more peace of mind.
Here are 11 things to know about escrow when buying a house.
Finding a home to buy is just the start of the adventure. Many home buyers and sellers know that escrow is a financial arrangement with a third party who holds money or other property until the terms of the sale are complete. But it’s more than that. Escrow covers the whole process of a home’s sale and includes the collection and management of documents related to the sale.
And it’s not a speedy process. The average escrow process timeline takes 30 to 60 days — even longer during busy times like the summer.
When an offer is made and accepted, buyers provide a set amount of earnest money. This is a deposit that acts as a good-faith commitment of your intent to buy a property. At that time, the escrow process begins with opening an account. The outside party who holds and manages the escrow account may be specified in the initial purchase agreement.
In some states, a real estate attorney manages the process. If this is the case, the process is referred to as “settlement.”
An appraisal is part of securing financing for the property. If it comes in low:
If none of these options fit, the sale can be canceled and the escrow account closed. Earnest money is refunded to the buyer at that point.
Even with a solid appraisal, financing is not guaranteed. Buyers with poor credit or a smaller house down payment may struggle to find a bank that will work with them.
Buyers who get preapproved for a mortgage have an advantage here, but there are still challenges. This stage of escrow totals up the closing costs plus other fees and costs of buying a house.
Some buyers are shocked by the final total. It’s important to ask your lender for the most accurate accounting of these fees so you can plan ahead.
Buyers can ask for contingencies when they first open an escrow account and sign the offer. The most common types of contingencies include:
Your real estate agent can suggest other types of contingencies, including an appraisal and financing contingency.
If you are purchasing an undeveloped lot, another contingency might involve the depth of water for drilling a well, flood zones, and other known hazards. Known hazards are part of a seller’s disclosure. If the conditions of the house or property are not satisfactory, the buyer can terminate the agreement if it is listed as a contingency or not properly disclosed.
Home buyers on a budget might be tempted to skip the home inspection. But doing this is “penny wise and pound foolish.” Skipping out on this part of the escrow process to save a few hundred dollars could cost you (tens of) thousands in the long run.
Home inspections look for defects in a home that are dangerous or costly. This includes:
The major types of insurance to obtain during the escrow process are:
Homeowners and title insurance are required, but hazard insurance is sometimes optional, depending on the lender. If you are buying in an area with a history of natural disasters, opting out of this coverage is a big gamble.
If your title company finds a cloud or defect — an issue with the title — it is up to the seller to make it right. Otherwise, buyers can cancel the sale.
One of the last steps in the escrow process is a final walk-through. This is available to buyers of any property, but it is critical if a home inspection has uncovered issues that the seller has committed to fix. A walk-through gives buyers a chance to verify the work has been done and that the house is in the appropriate condition.
At least 24 hours before closing, your lender will provide you with a HUD-1 document. This is the final total of closing costs and fees associated with the sale of the house. It indicates what the buyer is responsible for and what the seller is responsible for.
At this point, there should be no surprises. Compare it to your initial purchase agreement — it should be remarkably similar.
You've made it to closing. You understand how your mortgage works, the costs associated with the sale, and the terms of your loan. Once you sign all of the documents, the escrow process for the home sale is formally concluded.
However, that’s not the end of escrow. Most homeowners don’t know that every month they pay their mortgage with a portion of property tax and homeowner’s insurance that’s going into an escrow account, too. Your mortgage documents should break down how much is in the account and make adjustments for any overages or deficits.