What is Escrow?

Escrow

Escrow is a legal concept describing a financial agreement whereby an asset or money is held by a third party on behalf of two other parties that are in the process of completing a transaction.

Escrow accounts are managed by the Escrow Officer.  The agent releases the assets or funds only upon the fulfillment of predetermined contractual obligations (or upon receiving appropriate instructions). Money, securities, funds, and other assets can all be held in escrow.

In real estate, escrow is typically used for two reasons:

  • To protect the buyer’s good faith deposit so the money goes to the right party according to the conditions of the sale.
  • To hold a homeowner’s funds for property taxes and homeowners insurance.

Because of the different purposes served, there are two types of escrow accounts. One is used during the home buying process, while the other is used throughout the life of your loan.

When you’re buying a home, your purchase agreement will usually include a good faith deposit (also known as earnest money). This deposit shows that you’re serious about purchasing the home. If the contract falls through due to the fault of the buyer, the seller usually gets to keep the money. If the home purchase is successful, the deposit will be applied to the buyer’s down payment.

To protect both the buyer and the seller, an escrow account will be set up to hold the deposit. The good faith deposit will sit in the escrow account until the transaction closes. The cash is then applied to the down payment.

Sometimes, funds are held in escrow past the completion of the sale of the home. This is called an escrow holdback.  There are many reasons an escrow holdback may be needed. Perhaps you agreed that the seller can stay in the home an extra month, or maybe you found something wrong with the property during the final walkthrough.

If you’re building a new home, money may remain in escrow until you’ve signed off on all the work. Once the conditions are met, the money will be released to the right party.

An escrow account is key to protecting your deposit during a home sale. For example, say you have a purchase agreement, but the sale falls through due to a problem found during the home inspection. If you’d given your deposit directly to the seller, there’s a chance the seller wouldn’t return your deposit. But since the deposit is being held by a third party, you can be confident it will be returned according to your agreement.