If you’ve ever made an innocent bet with a girlfriend over who you think will win The Bachelor, you may have asked a third person to hold onto your money for safe keeping until the season finale. When you take out a mortgage to buy a new house, you’re essentially doing the same thing – ideally without the drama that goes down at the final rose ceremony. In the instance of a home purchase, the person who is responsible for keeping your funds safe is called an escrow agent.
Basically, escrow is a financial agreement between you (the buyer) and a seller whereby a third party (an escrow agent) holds your money in a special account pending the completion of the purchase agreement. Before the escrow agent can transfer your money to the seller, the seller has to fulfill a set of agreed upon obligations, called contingencies, which are attached to the contract.
Examples of these contingencies may include (but aren’t limited to) the following:
Proof of title. This contingency allows you to terminate the contract if the seller cannot provide a valid, legal title to the property that is for sale. You want to make sure you’ll have the full right to ownership before buying.
Property appraisal. As a buyer, you want to make sure you’re not paying more for a home than what it’s worth. If the home is appraised at a lower value than the purchase price you can back out of the contract.
Satisfactory home inspection. This contingency allows you to walk away from an offer if the home inspection reveals significant damages or flaws that ultimately result in your dissatisfaction with the condition of the house.
Necessary repairs. A home inspection will often lead to more negotiations between you and the seller. If, for example, the roof needs to be repaired in order to make the home safe, you can require that it be fixed prior to closing.
So, how much money will you be putting into this escrow account? It depends. There are three deposits a buyer makes throughout escrow:
Earnest money: Sellers rarely consider an offer without a deposit that shows you’re a committed buyer. Assuming your offer is accepted, this deposit will go toward your down payment and closing costs.
Down payment: The down payment must be put into escrow before the title transfers. The amount of the down payment is a percentage of the sales price and varies widely based on the type of mortgage secured.