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Real estate is full of foreign terms that can easily confuse home buyers and sellers. That’s why working with a good real estate agent is vital when you want to buy or sell a property. One of those confusing real estate terms is escrow.
Escrow is a process that plays a pivotal role in real estate transactions. However, many people find it hard to understand the purpose of escrow in real estate. That includes current home buyers who have paid into escrow without knowing the reason behind it.
Luckily for you, this article explains what escrow is and its purpose in real estate.
How Escrow Works in Real Estate
In real estate, escrow is used when two parties are in the process of completing a transaction, but it’s uncertain whether they can meet their responsibilities. And the purpose of an escrow company, such as Lightspeed Escrow, is to make all transactions regarding real estate.
When the seller is selling a house, he needs assurance he will receive the payment from his home buyer. Also, the home buyer will be ready to pay only if the house is in good condition. So, the home buyer can place the deposit in escrow with instructions to allocate it to the seller once all the conditions are met.
Escrow for Earnest Money
If you’re buying a house and making an earnest money deposit, make sure to ask your agent about their process for this. Some may manage the escrow process for you. With others, you may need to set up escrow by yourself. Or the title company you plan to use for closing may manage the deposit.
If you give the earnest money deposit to a seller, it could be difficult to retrieve it if the sale falls through. Therefore, both homebuyers and sellers must ensure the purchase agreement defines the conditions if the earnest money is forfeited or returned. For instance, will the home buyer get his deposit back if the sale falls through because of the issues found during an inspection?
When the time comes for the sale to close, the earnest money deposit will be released to count toward the total purchase price. Until then, escrow protects the home buyer’s deposit.
Escrow for Ongoing Taxes and Insurance Premiums
Many lenders demand escrow. And sometimes, escrow may be legally required. That said, if your lender requires escrow, the mortgage servicer will handle the escrow account and pay the insurance fees and taxes on time.
However, you may still receive notices of insurance premiums and property taxes that may say they aren’t bills, and that your lender has been notified. However, if you’re unsure your lender knows about that, consider contacting your mortgage servicer.
Who Manages Escrow Accounts?
Escrow accounts can be managed by different third parties, including escrow companies, escrow agents, and mortgage servicers. And the stage of your process will determine who handles the account.
Escrow Companies and Agents
An escrow company or agent may manage escrow when you’re buying a home. Note that, in some cases, the escrow company or agent is the same as the title company.
The escrow company handles the buyer’s deposit and may also be responsible for holding on to the deed and other documents regarding the sale of the property. Since the escrow company works for both the seller and the buyer, the fee for their services is typically split between them.
Mortgage Servicers
Mortgage servicers manage mortgages from closings until the loan is paid off. They are responsible for managing your escrow account, collecting your mortgage payment, and maintaining the payment records.
Your mortgage servicer may be your originating lender, but that’s not always the case. Sometimes, lenders will sell the servicing rights to your loan. That’s why you should check ahead whether your lender services their loans. Note that not all mortgage servicers offer the same level of service, and some will charge more fees than others.
When a mortgage servicer is taking care of your escrow account, you don’t have to send in your tax and insurance bills as he will know who to pay and when. However, if you change insurance providers or policies, you may need to provide the new policy information to your mortgage servicer.
Escrow Statements
Lenders must give borrowers their closing disclosure documents at least three days before a sale closes. This way, buyers have enough time to review their financing details and ask questions.
These documents will include an initial escrow disclosure statement when escrow is included in the loan. That said, your initial statement should contain:
- Total monthly payment
- Breakdown of monthly amounts for principal, interest, and escrow funds
- Anticipated monthly escrow payments
- Estimated disbursements
- Anticipated running balance
In addition, you should receive an annual escrow statement from the lender describing the previous year’s account activity, current balance, and projections for the following year. It should also define how potential shortages will be resolved or what will happen to any surplus.
The mortgage servicer can keep a cushion in the escrow account of up to one-sixth of what he expects to be the annual total required to pay the taxes and insurance. And you may receive a refund from your mortgage servicer if there’s a surplus in the account at the end of the year.
Escrow Fees
A portion of the closing costs will go toward escrow fees on the closing day. And the buyer, the seller, or both may pay these fees, depending on the sale.
Escrow fees go to an escrow agent, whom the seller and buyer have agreed to hire to facilitate the paperwork, closing process, and allocation of funds. This begins with the signing of the purchase agreement and ends when the keys are handed to the new owner. The escrow agent may be a title company, escrow company, or an attorney.
Escrow fees vary depending on the escrow agent, the terms of the sale, and location. But estimates of escrow costs are usually 1% to 2% of the home’s purchase price.
The Advantages Of An Escrow Account
The most significant advantage of having an escrow account is that you’ll be protected during a real estate transaction – whether you’re the seller or the buyer. It can also protect you if you’re a homeowner by ensuring you have the money for property taxes and homeowners insurance.
Let’s look into other benefits escrow accounts offer to buyers, owners, and lenders.
Home Buyers
An escrow account protects your deposit during a property sale. For instance, if you have a purchase agreement but the sale falls through because of an issue discovered during the inspection, there’s a chance the seller wouldn’t return your deposit if you’d given it directly to him. But, when your deposit is being held by a third party, you can rest assured it will be returned to you according to your agreement.
Homeowners
With an escrow account, you’re paying for your taxes and insurance throughout the year, making your payments more manageable.
In addition, you don’t need to keep track of various due dates as your servicer will ensure your tax bills and insurance premiums are paid on time. This takes the responsibility off your shoulders for any late payments. Your mortgage servicer will even cover bills for you if your escrow account lacks funds.
Lenders
Lenders have a vested interest in ensuring your taxes and insurance are paid. If your tax bills don’t get paid, the tax authority can put a lien on your property. And if the tax authority chooses to foreclose, it could cost the lender money. Also, if your homeowner’s insurance coverage lapses, considerable damage to or loss of the house may lead to a drastic loss of the home’s value.
That said, having an escrow account on the loan enables the lender to make sure the bills get paid.
What Escrow Accounts Don’t Cover
Note that escrow accounts don’t cover all the costs associated with homeownership. For instance, your servicer or lender won’t collect money to pay your homeowners association (HOA) fees or utility bills.
Escrow accounts don’t cover supplemental tax bills either, as your lender can’t anticipate when you’ll get this bill or how much it will be.
Do You Need An Escrow Account?
In some cases, you can pay for property taxes and insurance by yourself rather than by having an escrow account. This way, you will lower your monthly mortgage payment. However, you’ll need to save for tax and insurance payments on your own.
Note that not everyone can opt out of an escrow account on their loan as they are required on specific loans. For example, when it comes to VA loans, you’ll need a strong credit profile and a 10% down payment to opt out of having an escrow account. For conventional loans, you’ll need a down payment of at least 20%. And for FHA loans, all borrowers need to have an escrow account.
In addition, you may be able to use your escrow account for some expenses, while for others you won’t have to. For instance, sometimes lenders demand escrow for property taxes but don’t require it for homeowners insurance.
Finally, it’s up to you to choose whether you need an escrow account or not, provided that you can. But remember that although it may seem tempting to opt out of using an escrow account, having it will protect you from various unpleasant situations that can occur, such as not getting your deposit back in case the home sale falls through or paying your bills late.
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