The Escrow Process

An escrow company is a neutral third party that safekeeps funds on behalf of two opposite parties who are transacting with one another, usually in connection with buying a home. The escrow process involves using an escrow company to hold the buyer’s money once the buyer and seller have signed a purchase agreement in reference to real property.

When problems or confusion arise, a qualified real estate attorney can serve as a guide to the escrow process; a lawyer’s advice is especially useful alongside the support of a real estate agent.

Escrow as Contemplated by a Purchase Agreement

Because real estate is relatively expensive and most new home transactions run well into the hundreds of thousands, if not millions of dollars, buyers and sellers naturally share a mutual desire to ensure that the money used to purchase a house remains safeguarded in a neutral bank account until the close of escrow.

After entering into a real estate transaction, the homebuyer will want to inspect the property, consider whether it is suitable for a property exchange, secure additional financing from a lender, and ensure that the seller will be able to transfer title without any legal issues. Similarly, a homeowner who has signed a real estate purchase contract will want to make sure that his or her prospective buyer will successfully commit to closing the purchase and finalizing the transaction.

A purchase agreement will also need to provide for the allocation of expenses in connection with the sale, including brokerage and sales agent fees, closing costs, property taxes, escrow fees, and applicable credits and deductions. For these reasons, the purchase agreement signed by the parties will usually provide for a particular escrow holder to receive the buyer’s earnest money deposit, and ultimately the entire balance of the purchase.

Selecting the Right Escrow Holder

Because an escrow company is tasked with handling large amounts of money, and because it also has a duty to remain neutral as between the buyer and seller, it is very important for the parties to make sure that they select a qualified and reputable escrow holder.

Different states have designated governmental bodies to ensure that an escrow company is properly licensed and regulated. These include, for instance, the California Department of Financial Protection and Innovation, the Florida Office of Financial Regulation and Department of Financial Services, and the New Mexico Regulation & Licensing Department.

The Earnest Money Deposit

When a buyer and seller sign a real estate purchase agreement, the buyer will typically make an escrow down payment of one to three percent of the sales price as an “earnest money deposit” (E.M.D.) toward the purchase of the property. The E.M.D. is a good faith gesture from the buyer to the seller that the buyer is serious about entering into the purchase transaction and finalizing the sale.

Because the E.M.D. is usually due to be paid immediately after the buyer and seller have executed the purchase agreement, the parties begin working with an escrow company at the very outset of the real estate transaction. The E.M.D. is held in deposit with the escrow company, and for the average escrow period of 30 to 40 days, the buyer commits to a home inspection while the seller makes all required seller disclosures—e.g. those required by the Real Estate Settlement Procedures Act or R.E.S.P.A.—needed for the parties to finalize and close the transaction. During this time, escrow remains “open” until these tasks are completed.

If the parties encounter a dispute or are otherwise unable to move forward with closing escrow, the purchase agreement may need to be cancelled. Because an escrow company is a neutral third party, and because the parties will have signed escrow instructions allowing the escrow company to safeguard the buyer’s funds until the transaction is closed, neither the buyer nor the seller can unilaterally force the escrow company to release the buyer’s funds until either the transaction is mutually cancelled or otherwise finalized.

In the event of an irreconcilable dispute, court intervention may be warranted to allow the escrow company to release funds. Sometimes, if the buyer and seller fail to resolve their differences or if they are unable to go to court, the escrow company itself may file an action in court, called an interpleader, to request guidance from a judicial officer on how to properly relinquish escrow funds.

Title Insurance and Other Expenses Paid Through Escrow

Sometimes an escrow agent may also be part of a title company. One of the most critical elements of a real estate transaction is ensuring that the chain of title for the property is cleared while escrow is open. In other words, the buyer needs to make sure that the seller can pass proper legal title to the buyer, free of liens and defects, to finalize the transaction.

If a fault in title exists, such as one that casts doubt on whether the seller actually has enough rights in the property to be able to give it away as part of the sale, the buyer may suffer substantial damages. Funds in escrow are used, among other things, for the purchase of a title insurance policy (following a title search and title report) to ensure that the buyer’s investment is protected in the event the seller improperly transfers title.

Another function of escrow is to create an easily accessible pool of funds from which miscellaneous expenses can be paid. For example, if the buyer discovers that a termite infestation has diminished the value of the home, the seller may agree to issue a credit to the buyer. In this case, the buyer’s funds in escrow can be adjusted accordingly prior to the transfer of the money from the neutral escrow account to the seller’s bank account at the time of closing. In this manner, use of an escrow company can streamline the disbursement of funds to either party to a transaction, and a settlement statement provided by the escrow holder can help both sides track funds in reference to the home sale.

As demonstrated herein, escrow companies serve important functions that are crucial to most successful real estate transactions. Much like a final walk-through inherent to every new home purchase, using an escrow officer to facilitate the home buying process might likewise be one of the best decisions you ever made. If you are still unsure about the escrow process, consulting with a real estate attorney may be warranted especially if you are first-time homebuyer.