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What Is Escrow?

If you’re playing Scrabble and thinking of words that have to do with buying a house, then escrow could net you a lot of points.

Not only does it sound like a made-up word from a bag of letters, but you never really hear it until you’re buying a home. Or maybe you see a “For Sale” sign with “In Escrow” at the top and think, What the heck does that mean?  

Let’s take a look at escrow to find out what it is and explain why it’s important when you’re buying or selling a home.   

What Is Escrow?

Simply put, escrow is the process when a neutral, third party is in charge of holding something of value—usually cash—until a transaction between a buyer and seller is complete.

Simply put, escrow is the process when a neutral, third party is in charge of holding something of value—usually cash—until a transaction between a buyer and seller is complete.

Think of escrow kind of like a referee in a football game. They take no sides and make sure everyone is playing by the rules until the game is over. But the name of the game here is real estate.

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If you’re a home buyer or seller, being in escrow means different things:

  • As a buyer, you agree to pay a percentage of the price of the property into escrow for safekeeping.

  • As a seller, you agree to take the house off the market while it’s in escrow and make it available for inspections.

The main job of escrow is to ensure a fair and smooth real estate deal from beginning to end. You can use escrow accounts for other transactions like online shopping purchases (where the escrow service holds onto the money from the buyer until confirmation that the goods have been received). But right now we’ll take you through escrow in real estate.

Let’s dive in!

What Are the Different Types of Escrow?

As mentioned above, you’ll mainly use escrow for the biggest purchase you’ll make in your lifetime—a house! But you’ll also use it after you close on your home, too. 

Real Estate Escrow

Escrow in real estate starts when you find your dream home and the seller accepts your offer.

  • Your real estate agent will give you some recommendations on an escrow agent who both you and the seller agree on. This escrow agent could be a professional title agent, a real estate lawyer or a mortgage loan officer.

  • You’ll be asked to put down an earnest money deposit. This is a small percentage of the sale price of the house (between 1-3%) which you’ll make payable to the escrow provider. They’ll hang on to your money until the sale is final.  

The earnest money shows the seller you’re serious about buying their house. In return, they agree to take the home off the market, make it available for inspections, and carry out any agreed-upon repairs or provide disclosures to help see the sale through.  When you finally get to closing day, the earnest money will be subtracted from the amount you owe the seller and put toward the deposit or closing costs.

If for any reason the seller doesn’t make an agreed-upon repair by the closing date, then money can be held from them in escrow to cover the cost to you. And if the deal falls through? Don’t worry: You’ll get your earnest money back minus a small cancellation fee.

Homeowner Escrow Account

As we mentioned earlier, most mortgage lenders will request you have an ongoing escrow account for taxes and insurance when you’re asking them for money to buy a house. An escrow account is an account in your name, containing money paid in by you, and accessed by your mortgage lender.  

Your mortgage company sets up your escrow account after you’ve closed on your home, and you pay into it every month as part of your monthly mortgage payment. It’s not the most exciting account in the world because its only purpose is to pay for expenses like home insurance and property taxes. But it keeps you from having to remember to budget and pay for your property taxes and insurance each year.  

You’re usually required to keep two months’ worth of escrow expenses in your account at all times. That’s to make sure you’re covered if your taxes or insurance premiums increase unexpectedly.

How Does an Escrow Account Work?

Imagine it’s closing day for your house purchase. Yay! The champagne is on ice, and you’re signing the paperwork at your real estate attorney’s office. This is when you’ll get the breakdown of your monthly payment to the mortgage lender. Gulp!

Let’s say your monthly mortgage payment is $2,000. This is what it pays for:

  • The principal loan amount (the money they’ve loaned you to buy the house you’re about to move into)

  • The interest on the loan you’ve just taken out

  • Money for the escrow account to cover home insurance and property taxes

Think of the acronym “PITI” when it comes to your monthly mortgage payment.

P Principal  
I Interest  
T Taxes These parts of your monthly payment will go into your escrow account and be held by your lender to pay property taxes and home insurance each year.
I Insurance

The reason mortgage lenders want you to have an escrow account is so they don’t have to worry about you falling behind on these important expenses. In the end, you don’t want to lose your house, and they don’t want to lose the money they’ve just loaned to you!

Mortgage lenders want you to have an escrow account because they don't need to worry about you falling behind on important expenses like taxes and insurance.

And like we pointed out, an escrow account is also helpful to you because you don’t need to stress about making sure your property taxes and home insurance are paid on time each year. The escrow account does that for you! 

What Happens to My Escrow Account When I Sell My Home?   

Don’t worry: If you’re selling your home, your mortgage lender will refund any money in your escrow account within 30 days after the sale of the property. If you’re selling your home to upsize to a bigger pad, it’s wise to use your escrow funds from your old mortgage to go toward the cost of your new place.

Can I Avoid Having an Escrow Account?

You usually can’t avoid an escrow account because it’s mandatory when you take out a mortgage with most lenders. And if there’s a loophole allowing you to opt out of having an escrow account, there are a bunch of hoops to jump through.

First, you’ll need to have your mortgage for at least a year—and have no late payments during that time. Then you’ll have to give notice in writing that you want to opt out of escrow. And each year, you’ll have to provide written proof that you’ve paid your home insurance and property taxes on time.

For most people, it’s not worth the hassle! Most folks are happy to have an escrow account that takes care of all of that.

The Next Step to Your New Home!

If you’re looking for your next place to call home and want to find an agent who knows everything there is to know about escrow, closing costs and all the stuff in between, look no further! A house is the biggest investment you’ll ever make. Don’t even think about making that decision without a professional to guide you.

A top-notch real estate agent, like those in our Endorsed Local Provider (ELP) program, will help you navigate the home-buying process step-by-step to help you purchase a home with confidence. Our ELPs are industry experts with proven track records—not to mention great customer service.

Find a real estate pro today!

Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.

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