How Does Escrow Work?

How Does Escrow Work

When someone is going through the home loan process, homebuyers typically ask many questions, and one of the most common questions is regarding an escrow account. What is it? What is the process, and who can have one? In this article, we will go in-depth and discuss the question how does escrow work? 

What is an escrow, and how does it work? 

An escrow account is an account that your lender manages, and in this account, you pay a certain amount of money each month to pay out your taxes and insurance. Some persons may also consider having an escrow account as a so-called “reserve account.”

An individuals mortgage payment is separated into four parts:

  1. Principal
  2. Interest
  3. Taxes
  4. Insurance

The principal portion pays down the balance on your mortgage, the interest is the cost you as the homebuyer pay to borrow the money, and these parts of your mortgage payments never change. However, the taxes and insurance premiums do vary yearly. Let’s just say, for example, your insurance company may change their rates, or sometimes a new local levy may change your tax rate. 

Therefore, the taxes and insurance portions of your loan payments would go into an escrow account, and by doing so, the lender would pay off the home buyer’s tax and insurance on their behalf. Doing so would allow you, the home buyer, to break up insurance and tax payments into smaller amounts, protect you from making late payments, and eliminate the need to keep track of specific due dates yearly. 

What is an Escrow

Types of escrow accounts

As mention earlier, escrow accounts are like reserve accounts, and where we see it most often can be in real estate transactions, but there are also other types of escrow accounts that individuals can open. Some kinds of escrow accounts include:

  • Renters escrow
  • Construction escrow
  • Real estate sales escrow
  • Mortgage escrow
  • Independent home sellers or buyers escrow


Types of Escrow

Escrow Process 

The escrow process can be a lengthy one, but it is essential. Here’s a walkthrough of the escrow process. Once the parties: the buyer, seller, and lender, have signed their contracts, either party can open escrow. 

  1. Open Escrow –  Both parties make a mutual agreement on which company to use.
  2. Provide contact information and make introductions – The escrow officer will provide all the necessary contact information to each party involved in the deal. 
  3. Order title report – In most situations, title and escrow are done with the same firm. The escrow company will order a title report to verify any property’s liens, judgments, or other encumbrances. 
  4. Remove liens – If there are any liens on the property, the escrow company will try to remove those liens. The escrow company will also try to satisfy the buyer’s requirements to receive the property with a clean title. 
  5. Prepare legal documents – Immediately after the buyer has completed their due diligence and the lender has obtained and reviewed the appraisal, and a commitment is made to the buyer to loaning funds to transact in the property, the escrow company will prepare all the legal documents for each party to sign.
  6. Issue a closing date – Once each party reviews the legal documents, the escrow officer will issue a closing date. 
  7. Prepare a settlement statement – Soon after the closing date is set and all of the prorated taxes and rental income has been determined, the escrow officer will prepare a settlement statement. 
  8. The buyer and seller’s submission of funds and documents – The buyer will make sure all of their funds are in escrow, and the seller has signed the deed and is waiting to be transferred to the buyer. 
  9. Lender review documents and submit funds – The lender will examine all documents, approve the transactions, and wire their funds to escrow. 
  10. Escrow distributes funds and necessary documents –  The escrow company will issue the following; deed to the buyer, buyer’s money, and additional funds to the seller. 
  11. Escrow takes the new deed to the county to be recorded – The step is crucial because deeds are supposed to be registered with the county. After all, all real estate transactions are a matter of public record. Finally, when the new deed is recorded, the transaction is officially closed. 


Escrow Process 

Why do buyers use an escrow account for a purchase?

One of the main reasons buyers use an escrow account for purchase is that you do not stress paying taxes and insurance, but escrow does that. For many, this may be a massive relief, and it’s also convenient. 

Why do buyers use an escrow account

How can sellers use an escrow account to protect themselves from fraud and scams?

There are tons of scammers out there who seek to take advantage of sellers, and some escrow companies don’t use secure systems. So, every time money is supposed to be transferred to the escrow, the seller can make a phone call to verify any critical information before the money is being transferred onto any account. 

How can sellers use an escrow account to protect themselves

What are some common reasons why people might want to cancel an escrow transaction?

After both parties mutually agree upon the terms and conditions, they agree upon a closing day. This closing day will occur when the buyer and seller come in and sign all the paperwork and both parties have paid the closing costs. Furthermore, the closing date is when the buyer owns their new home, and the seller transfers the keys for the home. Also, note that this happens once the transaction has been recorded with the county and all information is recorded.

There can also be various reasons people may want to cancel an escrow transaction, which can be for both buyers and sellers. A few of those reasons are:

  • A real estate agent may not do an excellent job explaining the home buying process, and the buyer made a decision very quickly and later could end up leading to cancellation.
  • When there are repairs needed to be done on a property
  • When the buyer is willing to pay more, the seller accepts it, but the bank isn’t willing to fund that amount of money.

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