The process of buying a home can be confusing. You’ll hear a lot of terms being tossed around— some that you may understand and some that may leave you scratching your head. 

Escrow might be a term that sounds like a foreign language to many first-time homebuyers.

Escrow Explained

Escrow is a legal arrangement that describes a situation in which an impartial third party holds onto something of great value until a transaction has officially been made. 

Escrow assists in giving you leverage as a seller or buyer to ensure you get the right deal. Having aid in a major decision like refinancing your home, or buying/selling a home, can make all the difference in getting into the right financial situation.

Since sealing the deal is required for the money to be touched, that extra safety allows you to feel comfortable in the process, relieving a bit of stress that surrounds the process generally.

In terms of buying a home, escrow refers to the money that you will give to a neutral third party– an escrow service– and that third party will hold onto the money until both you and the seller of the property have successfully negotiated and finalized the purchase. The money you furnish is known as earnest money.

The money that’s placed in escrow cannot be touched by either you or the seller until after the deal has been sealed.

The Different Types of Escrow Accounts 

In the realm of real estate, escrow is used for two main reasons:

  1. To secure the homebuyer’s good faith deposit in ensuring the money goes to the correct party, according to the sale conditions that were previously laid out.

2. To hold a homeowner’s assets for insurance and taxes.

Because escrow can serve different purposes, there exist two types of escrow accounts. One is utilized during the home-purchasing process, whereas the other is used throughout the span of your loan. 

Escrow for Buying a Home

When you’re endeavouring to buy a home, the purchase agreement you make will typically include a good faith deposit (what we’ve previously defined as “earnest money”). This shows that you are serious about buying the home. If the contract that’s been agreed upon falls through due to the buyer’s fault, then the seller typically gets to keep this money. If the contract is successful, the money goes toward the buyer’s down payment.

In the interest of both the buyer and seller, an escrow account is set up to hold the earnest money. The deposit will remain in the escrow account until the transaction is completed. Then, the money is applied toward the down payment.  

How long have you been in the market to buy a home?

This will impact the experience you have with the industry going into this decision. Fortunately, escrow assistance will ensure regardless of how much you’ve been involved with the industry in the past, you’re getting the right information and your money is staying safe.

Getting a fair deal on your own is possible, and it’s still something you can do if you really wish to pursue this on your own. However, being fair to both parties makes the process pass much more easily, and again, that lifted stress is a burden off of your shoulders.

Often, deals can go sideways without the intention even from either party. If the seller is given earnest money on their own and there is no agreement that’s been thoroughly reviewed, there’s potential for issues to come up very easily down the road.

Escrow for Taxes and Insurance

After you’ve purchased your home, your lender may offer to establish an escrow account for the purpose of paying your taxes and insurance. After closing, your lender (or mortgage servicer) will transfer a portion of your monthly mortgage payment and hold it in escrow until your taxes and insurance payments are due. 

Since your taxes and insurance premiums can change on a yearly basis, the amount required for this type of escrow account is a moving target. Your servicer should determine what your escrow payments will be for the next year based on the bills that were paid the previous year. Most lenders require about two months’ worth of extra payments to be held in your escrow account to ensure that there’s enough cash for all your bills.