What is Real Estate Escrow?

Escrow is a deposit, most typically of funds and/or documents, that is held until paid out upon successful completion of the terms of the escrow instructions.  Technically defined, Escrow is a legal arrangement in which a neutral third party holds an asset during the period in which the conditions of the deal is being finalized by the other two parties.  In actuality it can be money, property, or really any asset of (perceived) value.  It can be used to transfer, or protect, personal and business property.  While the property may be business assets, or intellectual property such as software source code, escrow is most commonly associated with real estate transactions.

In real estate, escrow provides a form of mediation between all the participants in the transaction; buyers, sellers, lenders, agents, and title company. The escrow is a holding place for all funds, instructions, and documents necessary for the purchase of the home, including the buyers funds for the down payment, the lender’s funds and documents for the new loan, and the sellers deed.  When a buyer makes an offer on a property and the seller accepts the offer the buyer is expected to demonstrate the good faith of the offer with a cash deposit, also known as earnest money.  In the event the conditions of the sale are met but the buyer decides not to go through with the deal, the cash deposit is typically given by the escrow agent to the seller as compensation for having taken the property off the market in anticipation of the purchase being completed. It is important that the escrow agreement carefully defines what does or does not constitute a release event and that it provides a process for providing notice of any events to the parties, the correct process for any response or objection to such notices, and the dispute resolution procedures.

Typically, an escrow begins with the Realtor delivering the purchase contract and the buyer’s earnest money deposit to the escrow company.  The escrow company will prepare and deliver the initial escrow instructions and other related documentation. Once the purchase agreement has been executed, the purchase deposit made and an escrow account has been opened the buyer typically applies for a mortgage loan. Once the loan has been approved, the lender provides instructions detailing the conditions under which the funds can be disbursed. Bear in mind that the buyer must have the necessary insurance in place before most lenders will send the closing funds to the title company. Additionally, the lender may require that an escrow account to pay property tax and insurance during the term of the mortgage be established.

Closing costs associated with the transaction vary depending on the sales contract and may include items such as loan payoffs, inspections, any judgments or liens, recording fees, tax pro-rations, transfer taxes, notary fees and any other negotiated items.  Real Estate commissions are traditionally paid at the close of escrow from the Seller’s proceeds.  Another item settled during this transaction is title insurance, which insures the ownership of real property against any encumbrances to the title.  If a buyer does not elect to buy title insurance, they are not protected, even if the prior owner had title insurance.

Once the new title has been recorded, the escrow agent prepares and delivers closing statements to both the buyer and seller.  These statements should be reviewed in detail to ensure they are correct, and any inconsistencies within should be resolved before proceeding.  Prior to closing, the buyer and the buyer’s agent do a final walk-through of the home to verify that contract terms are met.

When the terms of the purchase agreement are met, the escrow agent assigns the property title to the buyer and distributes the funds to the seller, records the deed, closes the escrow. An escrow account will provide the participants in the transaction with a guarantee that no funds or property will change hands until all of the terms and conditions have been followed to both parties satisfaction.  The rules and procedures around escrow and closing can vary by region, title company, and lender.  Therefore it is often advisable to engage an attorney familiar with the process. Ultimately, the use of escrow is intended to provide security and peace of mind for buyer, seller, lender and Realtor alike.