If you’re buying a new house, there’s no doubt you’ve heard the term “escrow” being tossed around. You understand that escrow involves handing an earnest money check over to a neutral third-party (an escrow service) until the transaction of buying your house is complete, but you don’t quite get why escrow is such an important part of the home buying process. You can’t help but wonder: “Can’t you just keep the earnest money or hand it directly to the seller?”

The answer to the above question is a definite “no” (unless you want to run into trouble); but why? Let’s take a look.

What Is Escrow?

An 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. 

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.

Why is Escrow Important in the Home Buying Process?

The purpose of escrow is to protect buyers and sellers who are involved with the process of, well, buying and selling a home. Here’s why:

For the buyer. Sure, you could hand over earnest money check directly to the seller; but, if you did that, there’s a chance that he or she would dangle it above your head to get a deal that works better for them.

For the seller. Buyers can keep the earnest money until the transaction is complete, but the seller isn’t going to want to sign over the deed to the house until he or she knows the earnest money will be theirs.

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.

In other words, escrow ensures both the buyer and seller will get a fair deal.