The Different Meanings of Escrow - The Basics

The term escrow has two different meanings, both of which pertain to the holding of money by a third party. To help you better understand the difference, I’ll cover the basics in this post!

ESCROW – Meaning 1

What is escrow?

Once a buyer and seller have agreed on a price and contract for a home, the next step is for the buyer to put down a deposit or earnest money. To protect both parties, the money does not go directly to the seller, it goes into something called escrow.

An escrow agent is a third party that handles a real estate transaction between the seller and buyer. Escrow companies, title companies and sometimes even special attorneys will act as the escrow agent. When a deposit is made by the buyer, the money goes into escrow where it remains until all terms of the real estate contract are met and signed off by both parties.

Is there a fee involved?

Yes there can be a fee for escrow and it can vary depending on the state whether the buyer or seller pays it. The fee is generally a small percentage of the home purchase price, in the 1-2 percent range.

Who chooses the escrow company?

Both the buyer and seller choose the escrow company together. Real estate agents are good resources for finding reputable companies.

What happens to the buyer’s money once it is in escrow?

After the money is deposited in to escrow, it is the job of the escrow agent to ensure that all conditions and terms of the real estate contract are finished as stated in the contract. After each condition is met, both the seller and third party sign-off. The escrow money is normally applied to the down payment of the home. In the event of a contract not going through, the money will be returned to the buyer.

When will the escrow period be closed?

In order for escrow to be cleared all conditions in the contract must be met, the buyer’s loan must be approved and the title search must be complete. After this a new deed will be issued in the buyers name and the escrow money is released to the seller.

ESCROW – Meaning 2

What is an escrow account?

A mortgage payment is made up of principle, interest, taxes and insurance. An escrow account is something most mortgages lenders require a borrower to carry. The purpose behind an escrow account is to keep tax and insurance payments on-time and paid in the full amount regularly. An escrow account is held by the lender and is separate from the borrower’s mortgage account. It is designed to specifically hold funds to pay real estate taxes and homeowner’s insurance. During closing, the lender also collects a small portion of taxes and insurance to hold as a safety net.

How does the borrower pay the lender the taxes and insurance and how is the amount decided?

The lender estimates the annual taxes and homeowners insurance for the borrower’s home and divides that amount by 12 to equal 12 monthly estimated payments. This amount is then added to the principle and interest of the mortgage finalizing the full mortgage payment amount. There is no additional payment for the borrower. The lender must also issue yearly statements of the escrow account which a borrower can use to decide if the right amounts are being taken out given the most current taxes and insurance amount.

How are the taxes and insurance paid?

The lender handles all payments of taxes and insurances by withdrawing the appropriate amounts from the borrower’s escrow account and making the payments directly.

What if taxes or insurance go up?

If a borrower’s insurance and property taxes go up the mortgage payment will then be reassessed and increased appropriately. The extra amount saved from closing can help pay those increases as well. If taxes or insurance go down then the lender will issue a check for the overage that the borrower had paid.

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