Buying a house can be a complicated process for which most people are generally unprepared. One of those mysterious elements is the escrow process—also called the closing. This process, which occurs between the time a seller accepts the offer and the buyer gets the keys, can be overwhelming to many home buyers. It is a good idea to have at least a basic idea of the steps involved before you make an offer on a home.
The Difference Between Escrow & Escrow Accounts
First-time home buyers are often confronted with many confusing and unfamiliar terms, most of which are essential for any future homeowner to understand. This is especially true of those that refer to purchasing and financing.
“Escrow” is an important term for home-owners-to-be to become familiar with. Many new buyers get confused about the difference between escrow and escrow accounts. These are connected, but the distinction is important.
Escrow is a financial arrangement in which two parties enlist a third party (who is neither the buyer nor the seller) to temporarily hold money, paperwork, or other assets for a transaction on their behalf before the transaction has been finalized.
That third party, known as an escrow provider, helps make the transaction safer by protecting the assets of the buyer and seller until both parties have met their obligations for the agreement. Ideally, the escrow provider is a neutral third party who isn’t concerned with whether the buyer or seller comes out ahead.
- Escrow Accounts
An escrow account is an account where funds are held in trust whilst two or more parties complete a transaction. This means a trusted third party will secure the funds in a trust account. The funds will be disbursed to the merchant after they have fulfilled the escrow agreement. If the merchant fails to deliver their obligation, then the funds are returned to the buyer.
It is in the escrow account that your mortgage lender will deposit the portion of your monthly mortgage payments that goes toward annual insurance payments and taxes. This is designed to protect you from getting in trouble with the government or your homeowner insurance provider in the event that you fall behind on your mortgage payments. Taxes and homeowner’s insurance payments are due annually, but putting a portion of your total yearly payment into an escrow account each month helps ensure your annual payments to the government or your insurance provider aren’t delayed or missed.
Since both property tax assessments and insurance premiums can fluctuate over time, the amount of money in the account can be different from year to year. If they do not have sufficient money in the account, the mortgage lender usually temporarily covers the difference, notifies them of the situation and increases their monthly mortgage payment. Moreover, the lender is required to send them an annual escrow statement that shows all their payments and the balance on the account.
Escrow accounts also serve to protect your mortgage lender, who will have greater difficulty getting back the money they loaned you if you fall behind and are foreclosed upon.
What Does The Phrase “Being in Escrow” Mean?
The process of “being in escrow” is the timeline of purchasing a home from inception to execution. Once your offer has been accepted, a cash deposit (sometimes referred to as an earnest money) of 3% of the purchase price is delivered by the buyer to escrow. The escrow period can vary. If a loan is involved, the escrow period will most likely be 30 to 45 days.
Are Escrow Accounts Mandatory?
Escrow will be required on all high-risk loans—including those with a down payment of less than 20%—because you have less equity in the property. Many homeowners prefer their lenders to handle their insurance and tax payments this way in order to avoid the danger of being unprepared for a large annual or semi-annual bill. Depending on your loan program and your lender, you may be required to have an escrow account.
Loans that are guaranteed and insured by the Federal Housing Administration (FHA) require you to have an escrow account. While loans insured by the Veterans Administration (VA) do not require escrow accounts, most VA lenders do require them to make sure the property is insured.
If you have a conventional loan, it is up to the lender to decide whether or not an escrow account is required.
Paying Bills With Escrow Accounts
When you close on your loan, your lender will collect enough funds to establish an escrow account.
Each month, a portion of your mortgage payment will go into your escrow account, and your lender will use that money to pay your taxes and homeowners insurance bills when they are due. This spreads the amount over 12 months, making it easier on your bank account. And since your lender is making the payments, you won’t have to worry about remembering when they’re due.
Escrow Process for Purchasing a Home
While the length of the escrow period can vary from state to state, the key steps of the escrow process tend to remain the same for all homebuyers.
1. Earnest Money Deposit
As a homebuyer, you write an offer using a home purchase contract. This contract contains provisions about how you’re going to increase your commitment level as you move through the buying process. This commitment starts with an earnest money deposit, named as such because it’s a deposit made in earnest or in good faith of your intent.
Earnest money deposits are usually 1 percent to 3 percent of a home’s purchase price, depending on local custom and the pace of current market conditions (the faster the market pace, the higher the deposit). So if you were buying a $300,000 home, the deposit would be $3,000 to $9,000.
2. Lender’s Appraisal
Most often, the buyer will pay for an appraisal to be completed, which protects not only the buyer’s financial interests, but the mortgage company, as well. If the bank appraises the property under the purchase price, the lender will likely not approve financing unless the buyer can pay the difference in cash or the seller lowers the price to the appraised amount.
3. Obtain Financing
The next step is to secure financing. Typically, the buyer has been pre-approved for a mortgage well in advance of executing a purchase agreement. In general, first-time buyers need to verify at least two years of income and steady employment to qualify for a home loan. Though there may be ways to qualify with less than two years of employment.
Home buyers should also keep a close eye on their credit. Credit score requirements start as low as 580 for an FHA loan. But many lenders may set their own, tougher guidelines. And credit requirements may be subject to change from time to time.
4. Approve the Seller’s Disclosures
A disclosure document can be important for both home buyers and sellers. When an owner sells a property, they are typically required to disclose information in a written document. The requirements vary based on state and local laws.
In general, a disclosure document is supposed to provide details about a property’s condition that might negatively affect its value. Sellers who willfully conceal information can be sued and potentially convicted of a crime. Selling a property “As Is” will usually not exempt a seller from disclosures. Disclosure rules can affect anyone selling a home, but they’re especially likely to affect property flippers, who buy properties in order to upgrade them and resell them for a quick profit. Property flippers often deal with properties in poor condition.
Although not a requirement, it is highly recommended that a buyer get a thorough home inspection before closing. A professional home inspector will provide valuable information to the buyer, including whether or not there are any dangerous or costly problems with the property (example: electrical problems, bad plumbing, roofing issues, etc.).
If a home inspector does find problems with the property, the buyer may be able to back out of the purchase, ask the seller to fix the problems, or ask the seller to lower the purchase price to accommodate the cost of necessary home repairs.
In addition to the home inspection, buyers should consider a pest inspection, environmental inspection, and geologic report (especially for properties located in areas subject to earthquakes).
6. Hazard Insurance, Title Report & Title Insurance
Whenever there is a mortgage on a property, buyers will be required to have homeowners insurance until the loan is paid in full. Furthermore, depending upon a buyer’s geographic area, additional coverage may be required such as flood insurance. In addition to homeowners insurance, title reports and title insurance will be required by the lender.
7. Final Property Walk-Through
A final walk-through ensures that the property’s condition hasn’t changed since your last visit and that the terms of your contract will be met. Depending on your contract or local customs, a walkthrough may be informal or more formal. In a formal arrangement, you will actually sign a contract addendum confirming that you’ve done your walkthrough and everything is as it should be.
8. Closing Disclosure
Three days prior to closing, the buyer will receive a Closing Disclosure, which is simply a form that outlines a final statement of loan terms and closing costs. Buyers should take the time to compare this document to the loan commitment received at the start of this process from their lender.
9. Property Closing
Time to celebrate! This is the final step of the home buying process and it is sure to involve a lot of paperwork on behalf of the buyer and seller. After the paperwork is complete, the escrow officer will prepare a new deed to the property, naming the buyer as the new property owner. The buyer will also submit a cashier’s check or schedule a wire transfer to satisfy the down payment and pay for closing costs while the lender will wire loan funds to escrow so the seller and seller’s lender (if applicable) can be paid.
When Do Buyers Need an Escrow Account?
Many different lending institutions require an account for the following types of loans:
- Conventional Loans
If you buy your home with less than 20 percent down, your mortgage lender will almost certainly require an escrow account.
- High-Cost Loans
If you have a higher-priced mortgage that is based on higher levels than those determined by the Consumer Financial Protection Bureau, lenders will generally collect monthly escrow payments for the first five years of the loan or longer.
- Federal Housing Administration Loans
FHA-insured loans always require escrow accounts.
- Veterans Administration Loans
While the VA does not actually require escrow accounts, it does require that lenders ensure that property taxes are paid and properties are covered by sufficient insurance. Because of this, most VA lenders will require an escrow account.
Why Choose Citrus Heritage Escrow?
When choosing an escrow company there can be many important factors to evaluate. Fees, location, staff and even recommendations from friends and colleagues are all things to consider. With Citrus Heritage Escrow by your side, you can rest assured that when you receive your settlement check, you’ve gained the maximum benefit from your home sale or purchase.
Call us today with any questions or concerns. Our professional Escrow Agents will help you through this exciting yet confusing process. (951) 335-7200