May 16, 2022 Last Updated 02:19 AM EDT

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Escrow for Beginners

May 02, 2022 05:34 PM EDT

Escrow for Beginners
(Photo : Escrow)

Learning the meaning of escrow, how it applies to your home buying process, and crucial ways to prep for success with CEO and Founder of New Door Property Transfer, Alex Lopez

Journalists love their jobs because they get to interact with people from all sorts of backgrounds and expertises, then turn around and share their knowledge with the world. Who better to explain the world of escrow in the context of real estate than CEO and Founder of New Door Property Transfer, Alex Lopez?

Many people don't know the term escrow, its definition, let alone heard the word before age thirty. So we sat down with the master to learn the basics and beyond. Because at day's end, we can't all know everything - so we'd rather learn from the best of the best and share it with our readers.

"Most first-time (and even some experienced) homeowners are unsure of the meaning of escrow and how it can impact them," Lopez conceded.

Start Here

Simply put, 'escrow' is a noun, and it all boils down to contracts.

An escrow is a type of contract where a less involved third party holds onto funds, possessions, or in this case, property (assets) until the person or group whose items are in custody fulfills the specified requirements of that contract.

"If you've ever given someone your ID as collateral while you toured an apartment complex, it is similar to that, but on a larger scale," said Lopez. "Escrow is an insurance or security deposit that safeguards everyone involved, especially because the third party's sole purpose is to keep the assets safe until the main parties execute their obligations."

When purchasing a house, the listing agency or title company might hold the buyer's funds until the purchase contract is complete. The Earnest Money is typically held in escrow by the sellers real estate company they have the home listed with; or with the title company of which is providing the title services/closing

Why the Real Estate Industry Uses Escrow

Assets retained in escrow protect both home sellers and homebuyers during the closing process by remaining unattainable until the entire process concludes.

The home seller is, of course, granted peace of mind that the buyer will not take their home out from under them without fair compensation. Escrow assures the buyer that the BANK will transfer their money correctly and without risk of loss to the buyer.

"Think of it like shopping online," said Lopez. "If you buy something through a store that partners with PayPal, PayPal holds the funds until the store receives your order, sometimes longer if that item is of massive value. This feature might only last a few seconds, but it protects you and the online store from which you purchased. The main difference from escrow is that PayPal might not legally accept responsibility should your funds not get to the seller, and certainly not often should your item be defective somehow."

Let's Get Complicated: Two Approaches of Escrow

There are two ways in which the real estate industry uses escrow: The initial deposit when submitting an offer and during the entire span of the home loan.

When realtors and home buyers use escrow as the initial deposit, it guarantees that the payment funds stay protected and "shows good faith."

On the other hand, using escrow during the whole term of the home loan is beneficial for tax and insurance purposes. It ensures the taxes and homeowners insurance to be paid in a timely manner. 

Method Number One: Escrow for Home Buying

Escrow money is applied towards the down payment of a home after the buyer meets the sale requirements and the transaction closes. A listing agency will typically facilitate this by setting up an escrow account to hold the buyer's deposit until all parties are satisfied and ready to move forward.

Exceptions

It is essential to mention that there are occurrences when funds are held and protected after a home sale is done, known as an 'escrow holdback' or simply 'holdback.'

This penalty happens if something goes wrong with the sale. Examples of sale complications include home sellers changing the move-out date to a later time or a home inspection coming back with a negative report.

Method Number Two: Loan Term Escrow

The second motivation for buyers to get an escrow account is to designate a mode to pay taxes and insurance over the loan term. The lender often uses this tactic by taking a portion of the buyer's monthly mortgage payment, then retaining it until tax and insurance payments are due.

The portion taken differs based on premiums and statements, so lenders choose the amount the buyer needs for an escrow payment based on the buyer's accounts from the last year, usually demanding between four and eight weeks' worth of additional funds held in regularly-audited accounts.

"In other words, the lender wants to hold two months' rent on your account," Lopez explained. "Like how you pay your first and last month's rent at some apartments. I'm surprised at how many apartment metaphors I'm using today, but we all know how those work!"

The upside? Like taxes, if those regular lender audits show the buyer has been paying too much, the buyer gets an escrow refund. (Although the same is true if they find out the buyer hasn't been paying enough too.)

About New Door Property Transfer

New Door Property Transfer provides smooth home property title transfers and closing services for consumers, lenders, and investors. The company was founded in 2019 by CEO Alex Lopez, Founder of homewayre.com. For more information, visit www.newdoorpt.com.

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