For many home buyers, escrow is an important part of the buying process. In order to properly participate in a home purchase, people need to understand how escrow relates to buying a home, and when escrow accounts might be used after closing.
The essential premise of escrow is to place a neutral third party in a position to handle monetary concerns between buyers and sellers. In a real estate transaction, a prospective buyer will make a purchase offer and present it to the seller. If the seller accepts the offer, the buyer often provides some funds as earnest money. This money may be used toward a down payment or other costs, or forfeited if the buyer violates terms of the purchase agreement. All money paid into the escrow account is held until the sale is complete, or the agreement has been dissolved. Although the escrow account functions primarily to hold funds, it may also keep other important documents or financial records related to the sale.
An escrow account is held by a third party who has the knowledge of escrow accounts and can maintain the account properly for the determined length of time the account is needed. The third party is called an "escrow agent." Although the escrow agent may be a bank or other financial institution, the account may be also be held by a title company or other organization specializing in real estate. The escrow agent is responsible for making deposits or withdrawals from the account on the buyer's behalf, as specified by the contract.
Why Escrow Is Important for Home Buyers
For home buyers, access to an escrow account is a way for them to protect their investment and interest in the Gallatin home before the sale of the property has been closed. Without escrow, the buyer would have to provide earnest money directly to the seller, which could create a conflict of interest. Escrow serves to guarantee to sellers that the buyer has provided the earnest money required for the sale, and it protects the buyer from unreasonable use or retention of that money by the seller. However, even though the buyer is depositing money into the escrow account, the funds are not for the buyer's direct use. If the buyer decides to back out of the sale without cause listed in the purchase agreement, the buyer may have to forfeit all money in the escrow account as a penalty.
Escrow After the Home Sale
Although escrow is used most often during the sale, there are reasons that homeowners might need to use an escrow account once they own the home, as well. In many cases, lenders require that homeowners contribute a specified amount of money each month into an escrow account, to cover the costs of:
- Annual property taxes
- Homeowners association fees
- Homeowners insurance
Unpaid property taxes could create a lien on the home that supersedes the mortgage lien that the lender holds on the property. As such, it is in the lender's interest to ensure that these taxes are paid in full each year. If a mortgage lender does not require the use of an escrow account for these expenses, homeowners are expected to pay these costs independently.
What All Gets Paid into Escrow?
During the initial home purchase process, the escrow account holds the funds that will exchange hands between the buyer and seller. The buyer will need to deposit the earnest money into the account to show their intent to complete the purchase.
After the completion of all inspections and necessary repairs, buyers must finish the transaction by placing funds to cover all closing costs into the account. The assigned escrow agent will then release the funds to the seller or bank after finalizing all paperwork.
Once the homebuyer starts making their mortgage payments, a portion will go into the escrow account each month. These funds will cover the property taxes, homeowner’s association dues, private mortgage insurance and homeowner’s insurance when the annual payments come due. The escrow agent will authorize the payments at the indicated time to keep these accounts current and in good standing for the homeowner.
Depending on their home loan type, homeowners can elect to pay these things on their own, eliminating the need for their escrow account. They must check with their escrow agent to see if they are eligible for their arrangement.
Having a home "in escrow" is a vital part of the home buying process for buyers and sellers. With better knowledge about how escrow works, buyers can make deposits toward the purchase of the homes they want.
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