New Real Estate Agent Guide: Understanding the Basics of Escrow
Catch all the groundbreaking insights of Brian Buffini’s Mid-Year Bold Predictions 2024 , now available on-demand. Has there ever been a more complex time in the real estate industry? Brian gives you theinside scoop on what’s taking place behind the numbers. Watch now.
Are you ready to have a strong spring season, converting new leads into more sales and income? We’ve got you! At Buffini & Company, we provide the best services and resources that help thousands of clients reach their goals and beyond. Click here to sign up for a free business consultation to learn about how you can achieve that level of success too.
In real estate there are two types of escrow: during a transaction and during the term of a mortgage. The escrow process can also be complex and differ in different parts of the country (including even in the same state and/or county) so it is essential that a real estate agent is knowledgeable in the intricacies of their specific area.
1. Escrow During a Transaction
When a buyer submits an offer on a home, one of the first of many financial steps they take is to sign a purchase and sale agreement and deposit earnest money into an escrow account. These funds (in essence, a “good-faith” deposit) are usually 1-3% of the sale price.
The escrow account is managed by a neutral third party, such as a designated escrow company or a title company, who temporarily hold that money until the transaction is completed.
Different Types of Escrow Services Per State
Some states are “escrow states,” where a third-party escrow company handles the mortgage closing.
Other states use an “attorney state” model in which the attorneys coordinate the process. The specific tasks they are responsible for can vary state by state.
In some circumstances, the escrow process can be more complicated. In California, for example, an escrow company is “licensed” or “controlled.” A “licensed” escrow company, which is also known as an “independent” escrow company, is licensed by the Department of Financial Protection and Innovation (DFPI). This license can only be obtained after the escrow company has met and satisfied all of the licensing requirements set forth by the Escrow Law, which are enforced by the DFPI. A “controlled” escrow, which may be known as a “non-independent” escrow, is not licensed by the DFPI.
What an Escrow Account Does
This account is set up to protect the interests of both the buyer and the seller. For the buyer, it shows intent to buy the home. For the seller, the monies serve as financial compensation for the time the home was off the market. In some states, the escrow account serves as a holding place for both buyer and seller funds.
After earnest monies are deposited, a contingency period is established in which certain conditions must be met by the buyer and the seller. If those conditions are not met during that period, then a buyer can back out of the contract and retain their earnest money.
If the conditions are met but the buyer backs out of the transaction, the seller normally can retain the earnest money.
If all goes according to plan and the final transaction is successful, the earnest money is applied to the buyer’s down payment on the home.
Escrow Holdbacks
An escrow holdback is when some of the earnest monies are held back at the closing. These funds may be held in escrow until repairs or other agreed-upon conditions are met by the seller. Often these required repairs may have been discovered during the home inspection. Or if it is new construction, there may be some work that was not finished by closing.
2. Mortgage Escrow
One the sale is finalized the mortgage lender may establish an escrow account for the buyer. This may be required if:
- The loan is from a private bank or lender.
- The down payment is 20% or less.
Many lenders may require clients to deposit an amount equal to two to three months expenses into this account to establish it, although in some circumstances that amount may be higher or lower. These escrow funds are included in the client’s total monthly mortgage payment.
An Escrow Account Funds:
- Principal and interest on the mortgage.
- Property taxes.
- Insurance premiums.
An Escrow Account Does Not Fund:
- Utility bills.
- Homeowners Association (HOA) fees.
- Supplemental tax bills (such as a change in ownership or new construction.)
Escrow Interest and Taxes
If the client does not have an escrow account, they are responsible for paying their tax and insurance bills directly, as well as any subsequent late fees that may be accrued.
Fifteen states currently require lenders to pay interest on escrow accounts: Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon, Rhode Island, Utah, Vermont and Wisconsin.
According to the IRS, a homeowner may be able to “deduct state and local real estate taxes actually paid to the taxing authority and interest that qualifies as home mortgage interest.” (A client should always check with their tax advisor first to see if they qualify.)
Want to get more great content and learn about the fundamentals of creating a successful real estate business? We’ve got you! Sign up for the 100 Days to Greatness®. You’ll learn about buyer/listing presentations, negotiations, closing techniques and much more.
