Understanding the mortgage escrow process

If you’re getting ready to buy a home, there’s a good chance you’ll hear the word “escrow” at some point. Here’s what to expect in the escrow process.

What is escrow and how does it work?

Escrow is technically a legal process in which a third party keeps money in a designated account for a specified period of time until a particular condition is met, such as the performance of a purchase contract.

There are three common types of escrow accounts. The first is the one used for buying a house.

“The purchase contract usually includes a provision for the buyer to provide a down payment,” says Tom Trott, branch manager for Embrace Home Loans in Frederick, Maryland.

The down payment – typically 1% to 2% of the house price – is held in an escrow account until the contract is finalized, after which the funds will be used for the buyer’s down payment or closing costs. . If the agreement is canceled, the deposit will go to either the buyer or the seller, depending on what the contract says.

The second type of escrow account is managed by your mortgage lender or service agent, and the funds you deposit are used to pay for property taxes, home insurance, and mortgage insurance (if applicable).

A third type of escrow, if necessary, involves anything that is not resolved in the real estate contract.

“For example, if the seller has left furniture, has not completed repairs, or the property has been damaged, the settlement company may withhold the seller’s funds in escrow until the contract is fulfilled.” , explains Trott. “Once filled, the funds would return to the seller or be used to pay unpaid bills.”

Is escrow mandatory?

When buying a home, depositing money into an escrow account is required in certain circumstances.

“Conventional lending guidelines recommend escrow accounts for first-time home buyers and borrowers with poor credit, but they don’t oblige those accounts unless you deposit less than 20%,” says Chad Holsted, a mortgage originator with Silverton Mortgage, headquartered in Atlanta. .

Escrow accounts are also required for FHA loans, adds Holsted.

For VA loans, you must pay at least 10% to withdraw from an escrow account.

Steps involved in the escrow process

After you take out a mortgage and make an offer on a home, the escrow process involves several phases:

1. Open an escrow account

The first step is to open an escrow account, which is usually done by the seller, but can also be done by the buyer.

“Your real estate agent will receive your deposit, which will eventually be applied to your down payment and deposited into an escrow account held with a particular escrow company or department specified in your purchase contract,” explains Lyle Solomon, senior counsel at Oak View Law Group in Rocklin, California. “Your agent will initiate this process after you and the seller agree on a price and sign a mutually acceptable purchase contract. “

The escrow agent may be a real estate securities firm, bank, or other financial firm, or it may be a private third party tasked with the task. Alternatively, a lawyer can handle this process, in which case it can be referred to as “settlement” instead of “receiver”.

2. Home appraisal and inspection

Your mortgage lender will order a home appraisal. If the appraised value of the house is less than the offered purchase price, your lender will not give you the funds for your mortgage unless you are prepared to pay the difference in cash or the seller agrees to reduce the price. at appraised value.

As a buyer, you have the option (and should) hire a home inspector to carefully assess the home’s condition and livability.

“Your home inspector will take a close look at the structural integrity, electrical and plumbing, kitchen, bathrooms, windows, roofing and heating system and give you a report, which will detail all of the conditions. outstanding issues that need to be addressed and any repairs or upgrades that are recommended to be done, ”says James Orlando, vice president of Brooklyn MLS in New York.

You will also want to review the seller’s disclosures. The seller is responsible for reporting any negative conditions or known defects that currently exist with the home.

“You should receive a written statement from the seller indicating any obvious defects and review it carefully with your agent,” Solomon explains.

3. Obtain insurance coverage

Your mortgage lender will ask you to purchase home insurance for the property and pay for title insurance. Unless you get an additional homeowner’s insurance policy, title insurance primarily protects the lender from any legal challenges that might arise from defaults in the title to the property or the ownership of the home.

4. Final walkthrough

Assuming that all goes well with the appraisal and inspection – and nothing changes in your financial situation that could derail your mortgage approval – you’ll have the opportunity to tour the home just before closing for a visit. last check. This is to ensure that there is no further damage to the home and that the seller has fulfilled the terms of the purchase contract, such as leaving behind any appliances or accessories they got on. Okay.

“You generally won’t be allowed to back up at this point, unless the house has been seriously damaged,” Solomon explains.

5. Closure

At least three business days before the transaction closes, you’ll receive a closing briefing document from your lender with a final list of closing costs, including escrow amounts, Orlando says. Compare this to your loan estimate (which you received when you applied for the loan) to make sure there are no significant changes in costs.

“These two documents have a lot in common,” says Solomon. “Look for unnecessary, unforeseen or excessive expenses and mistakes. “

When it’s time to close, the Escrow Agent will create a document designating you as the owner and file it with the local records office, then transfer the funds to your escrow account so that both the seller and the seller’s lender can be paid, says Solomon. For the remaining deposit and closing costs, you will need a cashier’s check.

6. Pay insurance and taxes

After you buy your home, another type of escrow account is maintained by your mortgage lender or service agent, with the funds in that account going for property taxes, home insurance and (if you are required to have it) to mortgage insurance.

Your lender will divide these annual amounts by 12 and add them to your monthly mortgage payment. When these invoices are due, they will be paid on your behalf automatically from your escrow account balance.

“You will receive an annual escrow account statement once a year that details the incoming and outgoing payments from your escrow account,” adds Holsted. “You will also be informed of any shortfall you owe or any refund due within 30 days of preparing the statement. “

You may eventually be able to terminate a mortgage escrow account, although the restrictions on doing so vary from lender to lender. If that’s an option, you’ll need to be in good standing with your payments, Solomon says.

However, maintaining an escrow account can provide peace of mind – it ensures your bills are paid on time and you won’t have to keep up with them, says Holsted.

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Ruth R. Culp