What is an Escrow?
Strictly speaking: An escrow is a bond, deed or other document that is kept in the custody of a third, un-invested, neutral, party until conditions from the invested parties are met.
During your home buying process, you’ll very likely hear this term used in two different phases, and for two completely different purposes.
Once you’ve found that perfect condo, single story ranch, colonial, or whatever, you will make an offer to the seller. Once the seller’s accept an offer that you also find acceptable, you’ll then put down an Earnest Money Deposit.
Your Earnest Money Deposit does not go to the seller. Instead, it will go from your Realtor to a third, and neutral, party who will hold the deposit for now. That money will be held in an Escrow account until you and the seller complete the transfer of the property, or until you decide not to go through with purchasing the house.
In the case of the latter scenario, in most cases, the Earnest Money Deposit in escrow will be paid to the seller since you backed out of the deal. This will be in full or in part and may vary by each case, so check with your realtor to be sure.
In a nutshell…
The purpose of the Escrow Agent is to manage promised monies until the agreed-upon terms of a contract are met. It is not their job to take sides, or get involved in any other way. This process is designed to protect the seller and the buyer.
Sellers don’t want to sign over and deliver the deed to a potential buyer until they have money in their hand. On the other hand, as a buyer, you don’t want a seller to take your money and run. The escrow agent serves as an intermediary, with no skin in the game, to manage the Earnest Money for now.
An escrow does not come with a preset time limit. An escrow account, or monies in escrow, can be held for a day, or indefinitely. Essentially, the purpose of escrow is to show the buyer that you are serious about buying the house they are selling. At the end of it all, once all of the paperwork is signed and in order, you get the keys. Then, the escrow agent releases monies in the escrow to the seller.
After you’ve purchased your home, your lender will also come to you with this term, or another that means the same thing.
- Impound Account
Principal, Interest, Taxes, and Insurance (PITI)
Your loan documents will contain something called PITI which is an acronym for Principal, Interest, Taxes, and Insurance, placed into an escrow.
Your principal is the purchase price of your home. The interest is what you pay your lender for having faith in you. And, of course, it’s for loaning you the funds you needed for the purchase of your new dream home. Your Taxes and Insurance are also included in your mortgage bill. The reason is because your lender has vested interest in your maintenance of property taxes and various insurances.
How you pay out your taxes and the details of these payment plans usually vary in the smaller details. Regardless, the main points generally remain the same. At some point in the year, your lender will have to pay your property taxes and insurance premiums in bulk. So, what they typically do is bill you each month 1/12 of what these bulk payments are.
Those 1/12 payments, itemized on your loan paperwork, are placed into an escrow account until it’s time to pay these bills. Many lenders require their borrowers to keep extra in their reserves. But again, those are details usually hashed out between you and them, and will vary depending on the lender.