Once a seller has accepted an offer on his or her property, the home goes into escrow. During this process, the buyer and seller deposit pertinent documents. And, in the case of the buyer, deposit funds with an escrow firm until the parties meet the conditions of the sale agreement. At that point, the transaction can proceed. Unfortunately, the escrow process can fail.
Having your home loan application denied by the lender impacts your escrow and purchase plans in a few ways. A loan that falls out of escrow doesn’t necessarily mean your deal is dead, but the process of getting the application back on track likely will delay your closing. An extension of escrow, a seller notice to perform and cancellation of the contract are some options, depending on your specific escrow and the loan issues you are facing.
What is Escrow?
Escrow refers to a third-party service that is part of every home purchase. When a buyer and seller initially arrive at a purchase agreement, they select a 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.
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 It Mean to Fall Out of Escrow?
You may already know that escrow is an arrangement in which third parties hold and regulate the payment of funds required for two parties involved in a given transaction. The escrow process helps protect both buyers and sellers by ensuring that all necessary conditions are met before the sale is finalized. Well, when a home falls out of escrow, it means that the buyer and seller have failed to meet the conditions necessary for the sale to be completed.
Reasons Some Home Sales Fall Out of Escrow
Here are some of the most common reasons a home falls out of escrow:
- Financing Falls Through
One of the most common reasons a transaction falls out of escrow is that the buyer’s financing falls through. Typically, if a buyer has been pre-approved, a change in their status, like a difference in employment, new negative credit issue, accrual of additional debts, or a change in lender guidelines can cause the lender to cancel the financing.
You should always check a potential buyer’s financial status before accepting an offer, whether they are financing or paying cash.
- Issues With the Home Inspection
One common contingency in a real estate contract is that buyers have the right to inspect the property prior to closing. The inspection is meant to find any problems with the home and its systems so that both parties are aware of the conditions of the home before closing.
If the inspection finds any major issues or problems with the property, it could lead to a dispute between the buyer and seller about who should pay for repairs. This could lead to negotiations that may not be successful, and if both parties cannot agree on how to handle the issue, then the sale can fall out of escrow.
- Low Appraisal
In seller’s markets where there is limited housing inventory, bidding wars often raise prices beyond home values. This can lead to financing trouble when the pre-closing appraisal report comes back.
A buyer’s lender will not finance a home for more than the appraised amount, so the buyer will have to pay the difference in cash, the seller will have to come down on price, or the buyer can walk away.
- Liens or Title Issues
Before closing escrow on a property, the buyer’s mortgage lender will require a third-party company to complete a title search on the property. The objective is that the title is free and clear, but sometimes, this is not the case. Title searches can reveal all kinds of issues like outstanding liens, delinquent property taxes, and/or judgments for unpaid work on the home. Additionally, a title search will uncover any additional parties on the home deed, like a spouse or heir, who are required to sign off on the title transfer. And sometimes, that does not go according to plan, causing the home to fall out of escrow.
- The Buyer Has a Change of Heart
Lastly, an escrow can fall through if the buyer has a change of heart about purchasing the home. Once in escrow, buyers have the opportunity to freely back out of their purchase without any legal repercussions.
However, if they do back out and fall out of escrow without a valid reason, they may have to pay some penalties, such as a fee to the escrow company or a penalty fee to the seller. This is usually included in the purchase contract, so it’s important for buyers to read and understand all of its terms before entering into an agreement.
It is not unusual for buyers to back out of their purchase due to jitters or simply because they have found a better home, so it is important to make sure that buyers are ready to commit before entering into an escrow agreement.
Can the Seller Back Out of Escrow?
The seller can back out of escrow as well. The seller has the right to back out if they are not happy with the buyer’s financing or if they decide to keep the home rather than sell it.
The seller may also be able to back out if there is a legal issue that comes up during the escrow period. Additionally, if the buyer does not meet their obligations on time or does not fulfill all the terms of the contract, then the seller may be able to back out as well.
It’s important for sellers to consult their attorney before making any decisions about backing out of an escrow agreement. In some cases, they may be able to back out without penalty, but it depends on the specific circumstances and the property sale agreement.
What Happens When a Loan Falls Out of Escrow?
A loan that falls out of escrow does not necessarily mean your deal is dead, but the process of getting the application back on track likely will delay your closing.
- Escrow May Be Extended
You can request an extension of escrow from the seller if your loan can ultimately be approved. Your real estate agent helps you draft an extension of escrow request on an addendum to the sales contract. It requires seller approval to keep the escrow going.
- Deposit Refund or Forfeiture
If escrow is cancelled because your loan fell through, whether you keep your deposit depends on whether you removed your loan contingency. A diligent buyer, and buyer’s agent, places a contingency in the contract that states the buyer has a certain amount of time, say 17 days, to get a loan and remove the loan contingency. Should your loan not get approved within 17 days, you would likely not want to remove the contingency, unless you were absolutely capable of paying for the home or obtaining another form of financing.