When you buy a house, setting up an escrow account is part of the process. It’s not particularly glamorous or exciting, but it is easy and essential to protecting your interests. What are escrow accounts? How are they used in the real estate world?
Setting Up an Escrow Account
An escrow account is an account where money is safely held by a neutral third party (source). These accounts have a multitude of uses. Many businesses use them to hold funds advanced by a client. Many states require landlords to place a renter’s security deposit in an interest-bearing escrow account. In the real estate world, escrow accounts are used both during and after a home sale. The details of setting up an escrow account vary from state to state, but homebuyers shouldn’t worry. In many cases, your real estate agent or lender will either set up the account or walk you through the process. If you choose to do it, you’ll need to start by contacting the financial institution, escrow service, or real estate lawyer that all parties have agreed to work with.
The Benefits of Setting Up an Escrow Account
Why are escrow accounts valuable tools? As Realtor.com explains, they protect the interests of those involved:
- Establishing an escrow account provides a neutral third party who not only holds the funds but also acts as a mediator to settle disputes that arise.
- Escrow accounts help prevent fraud by making it possible to confirm that the expected funds are real and holding them safely until a contract is fulfilled.
- An escrow account creates a separate holding tank for funds intended for a specific purpose so that they don’t get mixed in with general monies.
- Using an escrow account is a simple way to break big bills into smaller chunks. A party can make regular small payments into an escrow account over a set period of time that add up to the amount of a large bill. This makes budgeting easier and ensures that the money will be available when the bill is due.
Escrow Accounts and Your Home Purchase
How are escrow accounts used during a home purchase? As The Motley Fool explains, real estate transactions are complex. In addition to the sale price, the need for services from several different professionals that are paid for by the buyer, the seller, or both together means that keeping track of who has paid in and who is owed funds can get tricky.
Regarding what goes into the account, there’s an earnest deposit from the buyer that’s put into escrow in return for the seller taking the property off the market. At closing, the buyer will also add the remainder of their down payment and funds to cover closing costs. Meanwhile, the lender will transfer the loaned funds to the account. In some cases, the seller may also contribute. After the loan is closed, the agent responsible for the escrow distributes the money. Payees may include the seller, the property’s lienholder, real estate agents, appraisers, record keepers, insurance companies, and the company that handled escrow.
Escrow Accounts After the Sale
Why would a homeowner need an escrow account after their purchase? As Nolo explains, many lenders require homeowners to have an escrow account set up for their property taxes and insurance. After all, the lender has an interest in the property that lasts for the life of the loan. They don’t want to lose the property due to a failure to pay taxes, and if its value is diminished by a disaster, they want insurance coverage that will allow them to recoup their losses. Many lenders will set up an escrow account for you and collect a portion of your estimated taxes and insurance premiums along with your monthly mortgage payments. Then, the company managing the escrow accounts makes those payments when they come due.
How else are escrow accounts used after a home sale? If the cost of planned renovations is incorporated into the purchase, an escrow account can hold the funds that will be used until it is time to disburse them. In some cases, the seller funds the escrow account. In others, the funds come from a renovation loan.