Escrow is a term that both homebuyers and sellers hear a lot about when they are completing a real estate transaction. There are a variety of uses for the term escrow, but it is mainly used to describe certain events of a real estate transaction. Overall, escrow is used to describe a contractual agreement that is being held by a non-biased third party before the finalization of a real estate transaction.
Earnest Money Deposits
Escrow is used during numerous parts of a real estate deal. The first place that escrow is used, in most cases, is when a buyer places down a deposit after their offer is accepted by the seller. The deposit money is held in escrow to ensure that no one has access to the funds until the purchase is completed fully. If a buyer chooses to complete the transaction, the money is credited to them during closing. If a buyer decides to back out, then the deposit money is released from escrow to the seller of the home.
Buyers who are purchasing their properties with loans will typically have escrow accounts set up by their lenders. After a purchase, property taxes and home insurance bills are sent to the lenders. Lenders use the money held in escrow accounts to pay both of these bills. While property taxes and home insurance policies are paid for annually, buyers pay their lenders monthly, and the lenders then place the money into the escrow accounts.
Lenders do not always require buyers to pay more than the needed monthly payments, but some do. These excess payments allow lenders to retain safety cushions in their escrow accounts in case property taxes increase, home insurance rates rise, or buyers are unable to make their payments. A majority of lenders currently want buyers to add the maximum amounts to their escrow accounts.
Real Estate Settlement Procedures Act Guidelines
The Real Estate Settlement Procedures Act (RESPA) regulates the maximum amount of money that lenders ask for their borrowers to retain in their escrow accounts. While RESPA doesn’t require buyers to open escrow accounts with their lenders, most lenders do.