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When you're buying a house, you may hear that some of the buyer's money will go into escrow. But what does it mean to be in escrow? We've put together a short article to help you understand what's going on.
What it Means to Be in Escrow
Many industries and organizations have certain things in place to provide checks and balances or provide some security to a party so they aren't taking too much risk.
For example, apartment complexes usually require a security deposit. This is to help pay for potential damages the property may incur from you living in the apartment.
In the mortgage world, escrow is one of these things put into place to provide some security. It's where a third party temporarily holds onto a property or a large sum of money. They release the money when a specific condition is met.
In the mortgage industry, there are generally two types of escrow used.
Type #1: An account that holds the homeowner's funds to pay for taxes. This is done throughout the lifetime of your loan by the mortgage company. This is the kind of escrow explained on the government's consumer finance site.
Type #2: During the homebuying process, it protects the home buyer's good faith deposit (also called earnest money)
The first one will become more important once you actually buy your home. The second is important for the home buying process. Let's talk about the benefits of escrow accounts.
Why Use an Escrow Account for Taxes?
Your lender has an interest in making sure you are able to pay your taxes each year. They also know that if you don't regularly put money away towards this big expense, you may be sticker shocked when the amount comes due and not able to pay.
That's why the lender will add your expected property tax to your monthly mortgage payment. They put the extra money in escrow so it can be paid from that account at the appropriate time.
Benefits of Using an Escrow Company when Buying a House
There are a lot of parties involved with the purchase of a home, but putting your money in escrow during the home buying process is mainly about protecting one party: the home buyer.
The main benefit of using an escrow account during this process is you get to protect your good faith deposit – also called earnest money. Your earned money is typically 1 – 3% of the home price. Since it's a lot of money, you don't want to risk losing it!
As an example of how it protects your money as a buyer, let's have a pretend scenario. Let's say you've submitted an offer on a home and it's been accepted. You are doing your due diligence on the home and hiring an inspector.
Unfortunately, the inspection finds a lot of things wrong with the home and you decide not to go forward with it. What do you think would've happened if you had given your money directly to the home seller?
Right – they may not return it! They won't exactly be happy that the sale fell through, and now they're aware of a bunch of things they need to fix.
Having your money in escrow means the seller never even touched the money. It's still safe and sound in the escrow account.
How Much Do Escrow Fees Cost?
Unfortunately, it's not absolutely free to put your money into escrow. Just like the other parties involved with the purchase of a home, the escrow company wants to be compensated for doing their part.
Typically the escrow fees will be between 1% to 2% of the final price of the home. This is just one of several closing costs involved with buying a home.
Putting your money in escrow is a good thing! It keeps it protected whether you're already a homeowner or in the process of becoming one.
If you have any questions, send us an email at email@example.com. We look forward to hearing from you.