What is Escrow and what is it for?

If you want to know what an escrow account is and what it is for , here we are going to tell you all you need to know. Escrow or an escrow account is what in Spanish is known as a guarantee deposit , a surety or trust . 

Here we explain why you need an escrow account when you want to buy a home, have a mortgage loan or are going to carry out some type of online transaction. 

What is escrow and what is it for? 

An escrow or escrow account is a financial arrangement in which two parties request a ” third party ” who is neither the buyer nor the seller. That third party, known as an escrow provider , helps make the transaction is more secure . Its function is to temporarily hold money, documents or other assets. Once both parties have fulfilled their obligations for the agreement, the escrow provider delivers the money, assets, or documents that it has secured.

Types of trusts (escrow accounts)

In real estate, escrow is generally used for two reasons:

  1. To protect the ” promise to buy ” deposit so that the money goes to the right place according to the conditions of sale.
  2. To retain an owner’s funds for taxes and insurance .

Because they serve different purposes, there are two types of escrow accounts . One is used during the buying and selling process of a real estate, while the other is used during the life of your mortgage loan.

To buy a house

When you buy a home, the purchase agreement usually includes a cash deposit (earnest money). This deposit is in good faith and shows that the purchase proposal is serious. If the purchase-sale contract is not fulfilled because of the buyer, the seller can keep the money. If the purchase of the property is successful, the deposit is applied to the buyer’s down payment.

To protect both parties , a deposit account is established to hold the money. The deposit remains in this account until the transaction is closed . In some cases, the funds are held in escrow after the completion of the home sale until both parties are satisfied.

For taxes and insurance

After purchasing a home, the lender or servicer may establish an escrow account to pay for taxes and insurance . The servicer takes a portion of the monthly mortgage payment and holds it in an escrow account until your taxes and insurance payments are due.

The amount required for the escrow deposit is variable as taxes and insurance premiums can change from year to year. Because of this, most mortgage servicers require an additional 2 months’ payment .

It is important to check with your credit counselor to find out the exact amount that will be withheld from year to year. The mortgage servicer will review the escrow account annually to make sure you are not charging too much or too little. If I raise too much money for taxes and insurance, he will refund the money. If he has collected very little, you will have to cover the difference.

For online purchases

Buying items or paying for third-party services online is particularly risky – you’re dealing with someone you don’t know anything about and may be many miles away (so taking legal action against a scammer would cost too much to be worth it).

That is why having a third party that guarantees that you will receive what you paid for is an excellent option. If your product arrived, or you are satisfied with the work done, you can release the payment . Otherwise, you will get your money back.

Advantages of having an escrow account

The biggest benefit of an escrow account is that you will be protected during a real estate transaction . It can also protect you as a homeowner by ensuring that you have the money to pay property taxes and insurance when the bills come in.

If you are going to buy a home.

  • An escrow account is key to protecting your deposit during the sale of a home.

If you are a homeowner.

  • An escrow account will relieve the pressure of getting the lump sum once a year to cover taxes and insurance. This is because the payments are monthly and more manageable .
  • You don’t have to keep track of all the different due dates. Your mortgage servicer will make sure those bills are paid on time , every time . That way, you are not responsible for any late payments.
  • In case your escrow account does not have enough funds, your mortgage servicer will cover the bills for you.

If you are a lender or guarantor

Do you think you are a guarantor or a lender? You need to make sure property taxes and insurance are paid:

  • If tax bills are not paid, the tax authority could place a lien on your home, which could end up costing a lot of money if the tax authority forecloses.
  • Having a loan escrow account allows you to ensure that your bills are paid.

Disadvantages of having an escrow account

When it comes to the downsides of an escrow account, it is the owner who finds most of the burden.

Higher mortgage payments. An escrow account is financed through your monthly mortgage payment , which makes your bill higher than it would be without an escrow.

Incorrect estimates. A significant tax increase  can occur repeatedly during the property’s first few years before it stabilizes. The mortgage servicer estimates the security deposit, but may not consider a large increase in property taxes. This is why the trust may fall short. If this happens, you will have to pay the difference out of pocket . The nice side is, your administrator will return the excess if there is money left in your security deposit after paying taxes and insurance for the year.

Changes in your monthly payment . The trust is calculated every year and, depending on whether it was short or had an excess of money, your administrator will prepare a new estimate.

How are the fees for an escrow account calculated?

Not all offer the same price and level of service, and some charge more than others. It will depend on the property, the type of loan, the condition it is in and other factors.

In the case of a cash deposit for the section of a property.

An example of a fare calculation in San Diego is shown below:

A escrow officer will generate a buyer and seller base deposit fee and calculate it based on the purchase price in a range of: $ 1.00 – $ 2.25 per $ 1,000 in price plus $ 250 – $ 500 Base Fee.

Calculation example: Purchase price $ 450,000

The base trust for this example will be $ 375 (average)

More per thousand fees of $ 1.50 = 450 x $ 1.50 = $ 675

For a purchase price of $ 450,000, an average deposit fee for the seller would be $ 1,050

The escrow buyer would also be charged a similar fee. There are a few key things to keep in mind when purchasing services. There are additional fees in addition to the above which may include transfer fee, courier, overnight stay, and storage fees.

For taxes and home insurance

As stated above, the amount needed for a trust depends on property taxes and homeowner insurance costs , which can change from year to year. The mortgage servicer will determine the amount needed based on the prior year’s bills.

Something very important to keep in mind is that when you first move into your home, your property is reassessed . This can cause your property taxes to go up, especially if your home’s value has increased. When a trustee estimates the security deposit, they may not take into account such a large increase in property taxes. Because of this, your trust may fall short. If that happens, you will have to pay the difference.

How to open an escrow account: Requirements

The escrow account is generally opened by the seller’s real estate agent, but can be opened by anyone involved in the transaction.

When opening an escrow account, the escrow officer will request the following information:

  • Property address
  • Sale price
  • Property type (for example, single family or duplex)
  • Full names and contact information for all parties involved, including email addresses
  • Purchase agreement, counter offers, annexes
  • Listing commission and sales commission percentage
  • Property name and phone number
  • Homeowners association, if applicable

Once the escrow officer receives a fully executed purchase agreement, a deposit number will be assigned to your transaction . After the escrow number is issued, the escrow officer will begin the next step: request a preliminary report or commitment from the title company and request the initial deposit from the buyer.

In the case of earnest money, the amount you will have to pay in cash varies, but generally goes from 1% to 2% of the final purchase price of your house. If you have agreed to pay $ 200,000, you will generally have to deposit $ 2,000 – $ 4,000  in cash into an escrow account.

In the case of monthly mortgage payments, the minimum balance for an escrow account is usually double your monthly payment . The CFPB (Consumer Financial Protection Bureau) notes that this gives you a two-month buffer. Under the Federal Real Estate Settlement Procedures Act (RESPA) if you must put $ 500 a month into custody, your minimum required balance would generally be $ 1,000.

How to choose an escrow company? 

Escrow accounts can be handled by a variety of third parties, including an escrow company, escrow agent, or mortgage servicer. The place where the process is determine who manages the account.

Trust companies and trust agents

The escrow can be administered by a specialized company or agent when you buy a home. Sometimes the escrow agent is the same as the title company (title company). The escrow company not only manages the buyer’s escrow, they may also be responsible for preserving the deed and other documents related to the sale of the home.

Because the escrow company is working for both the buyer and the seller in the real estate transaction, the fee for their services is generally split evenly between the two parties.

Mortgage servicers

A mortgage servicer manages your mortgage from the closing of the sale until you pay off your loan in full. Mortgage servicers are responsible for collecting your mortgage payment , maintaining payment records , and managing your escrow account. Not all mortgage servicers offer the same price and level of service, and some charge more than others.

It is also important to consider the state of the American union in which you are located since each state has different regulations and therefore, their requirements may vary.

Also, look for indications that the escrow holder is a trusted impartial third party. Custody departments overseen by real estate brokers, mortgage brokers, banks, and title insurance companies are not required to follow such stringent regulations as those imposed on independent escrow companies.

Independent companies are licensed by the Department of Business Supervision , and required to meet rigorous requirements designed to protect consumers.

Here are some things to keep in mind when calling a trust company:

  • What are the total costs based on the purchase price?
  • Where are they located and how close is it to your home or work?
  • Do you offer any insurance to protect you once the transaction is closed?
  • How much experience does the escrow officer have with these types of transactions? If you can, talk to the Trust Officer to get an idea of ​​the adjustment.
  • What are the online company reviews?
  • Are they friendly and helpful when you call?

Finally, negotiate a bit with the company and make sure you get what you paid for.

Final recommendations

It is important to have an escrow account when buying a home. It protects you during the transaction, plus it offers a convenient way to pay your taxes and insurance. Sometimes a deposit account is required and sometimes not. This depends on the type of loan you obtain, as well as your financial profile.

It can be tempting not to open a trust, as it means a lower monthly mortgage payment. However, the escrow can actually give you peace of mind by ensuring that those important bills are paid.

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