Escrow 101: What Homebuyers Need to Know About Escrow

Escrow 101

When buying a home or piece of property, a new concept seems to exist at every turn of the corner. The real-estate-specific term escrow is one such example. Although escrow sounds complex, it actually denotes a straightforward process, built to protect the best interests of everyone involved in the transaction. In simplest terms, escrow denotes the practice of an independent third party temporarily holding money that is transferred from the homebuyer and lender to the seller of a property while the purchase is finalized and all the work contained in that process.

Escrow derives from the Old French word “escroi,” (which translates to “a piece of parchment”), and was based on the practice of allowing a third party to hold a deed until all the terms laid out by two parties for an agreement were fulfilled. While the mechanisms of the escrow process have advanced since its etymological origins, the idea is basically the same. Purchasing a home entails the transfer of large amounts of money from one party to another. In order to guarantee that everyone involved in the transaction is protected during the process, placing the money in escrow (i.e., with that neutral third party) guarantees that the process goes smoothly and according to plan. That being said, understanding escrow can ensure your peace of mind as you undertake this final process of procuring a home or piece of property.  Here in further detail is what every homebuyer needs to know about escrow.

Why Do We Need Escrow?

As any home buyer knows, purchasing a piece of real estate involves many moving parts. When it comes time to finalize the purchase, there are several financial and legal transactions that need to be completed in a systematic and thorough manner for a successful closing. The transfer of funds from the homebuyer and the lender to the seller of the property is one such transaction. Placing the money in escrow ensures several important aspects are secured, including:

  • Protecting all involved parties from fraud: Imagine handing over the money for a home, only to have the seller withhold the title. Or imagine receiving the funds for a property, only to find out that the secured loan is fake. Escrow protects against any such situation.
  • That the property is ready for transfer: Escrow provides homebuyers and sellers the necessary time and space to validate all financial and legal aspects of the deal. A few examples of the due diligence performed during the escrow process include making sure that no legal issues encumber the selling of the property, that the mortgage is verified, and the seller is actually allowed to sell.
  • That the final terms are clear and understood: The escrow process brings all parties into alignment on the final terms. An escrow agent will walk the homebuyer through the final paperwork as it is filled out and notarized, ensuring the transaction is 100% understood.

In some instances, escrow isn’t technically necessary for the purchase of a home, such as when the homebuyer doesn’t require a loan. However, the legal protection provided by escrow means that it is almost always utilized in the closing process.

How Does Escrow Work?

In real estate parlance, “escrow” is often used synonymously with “closing” because it is the final procedure in the homebuying process: once escrow is completed, the property has officially changed hands. So while the technical definition for escrow involves the transfer of funds between participants, it also denotes the work involved between those participants to build the confidence necessary for the money changing process to legally occur. That being said, the workflow for escrow follows a standard pattern. Once the homebuyer receives lender approval, all the money necessary for the purchase of the home is deposited in escrow under the care of an escrow agent. This agent is often a licensed professional within a title insurance company, although that condition varies from state to state. California, for instance, has separate escrow companies that handle the closing and distribution of funds; other states require an attorney to act as the holding party.

Whoever is responsible for overseeing the escrow process, the duties performed are essentially the same. The agent (or attorney) will deposit all funds in a depository account, thus kicking off an appraisal process. Once that work is complete, the real estate agent, the escrow agent (and the title agent, if that person is separate from an escrow agent), will oversee the scheduling of fees, the signing, and notarization of relevant documents, and finally, the release of funds from escrow to the respective parties. The escrow agent oversees this entire process, ensuring that every document follows proper protocol for submission, while also walking the homebuyer through every signed piece of paperwork in order to make sure it is clear. The agent provides the homebuyer copies of the finalized documents and instructions on how to complete the final step of purchasing a home: procuring a title policy.

So what is the financial rundown of what a homebuyer can expect to eventually put into escrow? The majority of the deposit will include all the money necessary for purchasing the home, including the payoff for all existing mortgages, and payment of the balance of the sales price after mortgages are paid. In addition, a homebuyer is expected to cover other closing costs, namely real estate broker fees and commissions, mortgage fees and commissions, title, homeowner’s and mortgage insurance, taxes, recording fees, and payoff of any existing judgments or liens. As far as the cost of using escrow, most homebuyers can expect to pay a fixed fee of $400-$500, although in some states (like Illinois) that cost will run higher. A homebuyer can expect their real estate agent to provide a thorough explanation and breakdown of these numbers.

The escrow agent oversees this entire process, ensuring that every document follows proper protocol for submission, while also walking the homebuyer through every signed piece of paperwork in order to make sure it is clear.

In Closing

Considering all the time, energy, and hard work that homebuyers invest in purchasing a home, escrow usually feels like a “downhill from here” experience. You can rest assured that, having accomplished so much of the home buying process beforehand, that closing will easily unfold. However, if you, as a homebuyer, do have any concerns, be sure to direct them to your real estate and escrow agent. These professionals will be able to provide clear guidance on the process and any particulars as they relate to your situation. In the meantime, you can also learn more about the ins and outs of the home buying process by exploring these resources here:

If you would like to learn more about Doma and how we help improve the closing process for homebuyers, please get in touch here.