When I became a new owner of a home, I felt like I didn’t know what I was doing. I remember hearing so many terms that were new to me: escrow, homeowner’s insurance and property taxes, oh my! It made me wonder, what the heck is escrow? I knew if I was asking these questions then there would be others who did as well. So after learning more about it myself, I wanted to put together a guide to help answer the questions around the financial transaction of a home sale and purchase that other first-time buyers may also have: “what is escrow and how does it work?” and “when does escrow start?” Knowing these is crucial for individuals who are planning to buy, sell, or build a new home.
What Is an Escrow Account?
An escrow account is a financial arrangement where a neutral third party holds funds for two + parties in a transaction. The third party, known as the escrow agent (or escrow officer), is responsible for safeguarding the funds and ensuring that the conditions of the transaction are met before the funds are released to the intended recipient. Escrow serves as a protective measure, ensuring that funds are handled appropriately during a real estate transaction.
The first step of the process typically begins after a prospective home buyer has met with a real estate agent and is ready to make an offer on a home. Once the buyer and seller enter into a purchase agreement, the next step in the closing process is opening an escrow account. An escrow account holds the buyer’s good faith deposit, as well as funds for property taxes and homeowners insurance.
Types of Escrow Accounts
When it comes to buying or owning a home, escrow accounts are an important part of the process. There are different types of escrow accounts that are used for different purposes.
Escrow Accounts for Home Buying
When you are in the process of buying a home, you will typically have to provide an earnest money deposit. This deposit shows the seller that you are serious about purchasing the home. The escrow account is set up to hold the deposit until the transaction is completed. If the sale falls through due to the fault of the buyer, the seller usually gets to keep the deposit. However, if the sale is successful, the deposit will be applied to the buyer’s down payment or any closing costs.
Escrow Accounts for Taxes and Insurance
After you have purchased a home, your mortgage lender will typically establish an escrow account to pay for your taxes/insurance. A portion of your monthly payments will be held in this account until your tax and insurance payments are due. And then of course, the principle and interest portions of the mortgage loan will come out of this as well. The amount required for escrow may change from year to year. Your lender will analyze your account annually to ensure that they are not collecting too much or too little.
Establishing an Escrow Account
To establish an escrow account, you will need to provide certain information to your mortgage lender or servicer. Some necessary documents they will request include your property tax and insurance bills. Your servicer will then determine the amount that needs to be held in the account based on these bills.
Escrow Analysis
As mentioned earlier, your lender will analyze your escrow account annually. If they have collected too much, they will give you an escrow refund. If they have collected too little, you will need to cover the difference.
Escrow Holdback
An escrow holdback is another type of escrow account that may be used. After the sale of a home has complete, it is used to hold funds until certain conditions have been met. One condition is if the property needs necessary repairs (based on the seller’s disclosure or found during an inspection period). Or if the seller needs to stay in the home for an additional period of time.
Establishing an Escrow Account for Taxes and Insurance
To establish an escrow account for taxes and insurance, you will need to provide certain information to your lender. They will need things such as property tax and insurance bills. Your lender will then determine the amount that needs to be held in the account based on these bills.
Sources:
– Bankrate
When Does Escrow Start?
Understanding when your escrow starts is essential in ensuring a smooth transaction. In this section, we will discuss the different timelines for setting up an escrow account, as well as the escrow timeline for home buying, taxes, and insurance.
Setting Up an Escrow Account
Once you and the seller have agreed on a purchase price and a purchase contract, a good faith deposit is made by the buyer. Escrow accounts for property taxes and insurance are typically set up by your lender after you close on your home. Your lender will collect a portion of your monthly mortgage payment and hold it in the escrow account until your tax and insurance payments are due.
Escrow Timeline for Home Buying
The number of days or amount of time for an escrow period in a home buying process can vary depending on the specifics of the transaction. However, in general, the escrow process can take between 30 to 60 days to complete. During this time, the buyer will have the opportunity to conduct a home inspection, finalize financing, and complete any necessary paperwork.
Once all aspects of the purchase are finalized, then the closing agent can close escrow, and the funds held in escrow will be applied to the down payment or closing costs. In certain circumstances, such as an escrow holdback, funds may be held in escrow beyond the sale’s completion.
Escrow Timeline for Taxes and Insurance
After closing on your home, your lender will establish an escrow account to pay for your property taxes and insurance. The timeline for this escrow account will depend on when your tax and insurance payments are due.
Again, it’s important to note that the amount required for escrow can change from year to year. This is based on your tax bill and insurance premiums. Lenders often require a minimum of two months’ worth of extra payments to be held in your account to ensure there is enough cash in escrow.
Conclusion
In summary, escrow is a process that protects both buyers and sellers in a real estate contract. It ensures that the right party receives the good faith deposit and that the funds for property taxes and homeowners insurance are properly allocated. Escrow accounts are typically set up during the home buying process and can be used to hold funds until certain conditions are met. Additionally, lenders may establish an escrow account to pay for taxes and insurance after the home purchase is complete. These accounts are monitored annually to ensure that the right amount of money is being allocated. Understanding how escrow works is an important part of the home buying process and can provide peace of mind for both buyers and sellers.
