When you enter the real estate arena to buy or sell a home, you will likely hear your lender or real estate agent use the word “escrow”. The term escrow can describe a few different functions, from the time your offer is accepted to the day you close on your home — and even after you become a homeowner with a mortgage.

The concept of escrow can be a confusing topic to get a firm grasp on. But, it is a very important concept to understand and learn

Read on as we break down the process in easy to understand terms and guide you through all you need to know.


What Is Escrow?

Escrow is a term that refers to a third party hired to handle the property transaction, the exchange of money and any related documents.  Escrow has to do with a certain amount of money being held by a third party for two independent parties until the agreement of a contract is finalized, such as when the purchase of the house is completed.

Escrow in real estate, as stated earlier, is when a third party holds the cash of two independent parties (buyer and seller) until the transaction is completed. The buyer and seller select this neutral third party to act as the escrow agent. The escrow agent collects a deposit from the buyer that is equal to a small percentage of the sale price. This deposit is known as “earnest money”. In exchange, the seller takes the property listing off the market. Until the final exchange is completed, both the seller’s property and the buyer’s deposit are said to be in escrow.

In order for this process to go through without a problem, the parties focus on the fulfillment of the purchase contract, the transfer of the buyer’s purchase money, prorated property taxes, and completion of required disclosures among other tasks. Escrow also ensures a clean and clear transfer of title.


How Does an Escrow Account Work?

Escrow accounts are a part of the mortgage process homebuyers typically cannot avoid. With mortgages, home buyers typically pay a little extra into an escrow account every month, along with their home loan payments.

While a mortgage holder (most typically a bank) collects the principal and interest payments each month, they also can collect homeowner’s insurance payments and property taxes. They will then pay those bills when they come due. They do this because when you borrow money from a lender to finance your home purchase, the property becomes the collateral for your loan. Your lender needs to know that the property is adequately insured so that it can be repaired or replaced if damaged. Likewise, they want to prevent a tax lien being placed on the property if you neglect to pay taxes.


What Does “In Escrow” Mean?

When you hear the phrase “in escrow”, it means that all items placed in the escrow account (earnest money, property deed, loan funds) are held with an escrow agent until all conditions of the escrow arrangement have been met. The conditions usually involve receiving an appraisal, title search and approved financing.

While the earnest money is in escrow, neither you nor the seller can touch it. Once conditions are met, the earnest money will likely be applied toward the purchase price or your down payment on the home.


When is Escrow Needed in a Mortgage?

Most lenders require (or at least encourage) you to have an escrow account, especially if you provide a down payment that is less than 20% of the purchase price. Many government-backed mortgages require an escrow no matter your down payment, including FHA and USDA loans. While you may not be required to set up an escrow account, you can choose to open one voluntarily to break up insurance and property tax payments into smaller amounts, keep track of payment due dates and avoid surprise bills at the end of the tax year.

An escrow account for paying property tax and homeowners insurance is generally required by lenders who originate VA, FHA and conventional loans. In certain circumstances, lenders may allow the homeowner to pay the property tax and home insurance as a lump sum instead of setting up an escrow account. If you waive escrow, be aware that some lenders may charge you a fee or an increased interest rate.


Escrow Protection During the Real Estate Buying Process

At different stages of a home purchase, the use of escrow accounts has benefits for the homebuyer and if the home is financed, the mortgage lender. The biggest benefit of having an escrow account is that it ensures that the funds being exchanged are secure and that they will only be released once all the conditions of the agreement have been met. This provides added security and peace of mind for both parties.

It can also protect you as a homeowner, ensuring you have the money to pay for property taxes and homeowners’ insurance when the bills arrive. You will find that there are a few other great benefits for home buyers, owners and lenders, too.


  • For Home Buyers

An escrow account is key to protecting your deposit during a home sale. For instance, if the sale falls through due to a problem found during the home inspection, you are more likely to get your deposit back if the money is held by a third party than if your deposit went directly to the seller.

  • For Homeowners

An escrow account takes the pressure off the homeowner to come up with a lump sum to cover taxes and insurance. Since you are paying for your taxes and insurance throughout the year, the payments are much more manageable. You also do not have to keep track of all the different due dates. When your tax bills and insurance premiums are due, your mortgage servicer will make sure those bills are paid on time, every time. No more late payments. Your servicer will even cover bills for you if your escrow account is short on funds.

  • For Lenders

Lenders have a vested interest in making sure your property taxes and insurance get paid:

  • If your tax bills do not get paid, the tax authority could put a lien on your home – which could end up costing the lender money if the tax authority chooses to foreclose.
  • If your homeowner’s insurance coverage lapses, significant damage to or loss of the home could lead to extreme loss of value of the home.


The Escrow Officer

An escrow officer (also known as an escrow manager or an escrow agent) is a professional who acts as a third party during real estate closings and transactions. They do not work for the buyer or the seller of the property and must remain impartial to ensure that transactions are handled fairly and legally. If the closing is successful, the escrow officer will also approve and handle the disbursement of all involved funds.

Escrow officers essentially close real estate transactions, but they also handle funds that have been deposited, monitor the status of earnings on those escrow funds to make sure they are returned to the party who deposited the monies and review contracts and titles to ensure proper filings with local assessors and county records officers. An escrow officer is the person who performs the final steps in property acquisition.

Escrow officers typically work for title companies, mortgage lenders or credit unions. During a home’s closing process, the escrow officer is responsible for processing any necessary paperwork, witnessing the document signings and explaining the companies’ services to prospective home buyers. The primary function of the escrow officer, however, is to establish escrow accounts for home buyers and to maintain the funds and records of such accounts. Because of the nature of escrow proceedings, many officers have knowledge of both finance and real estate.