Escrow 101: What is Escrow in Real Estate?

If you’re getting started as a real estate professional, you can expect to hear many new words and phrases as you help buyers and sellers close on their homes. For example, you’ll often hear the term “escrow” as it’s a big deal in the buying and selling process.

So, precisely what is escrow in real estate? Escrow begins when a seller accepts a purchase offer—and ends when the buyer takes possession of the property. As a real estate agent, you’ll play a significant role in the escrow process, so here’s what you’ll need to know about it.

Step 1: Open an Escrow Account

Let’s say you represent the home buyer who has just submitted an offer on a home they like. Escrow begins once the seller accepts the offer, and it’s time to open an escrow account. This is an account where you’ll deposit the earnest money that the buyer pays—which should be 1% to 2% of the purchase price. This will go toward the down payment or closing costs on the home. 

The earnest money is paid so that if the buyer changes their mind and backs out, the seller gets a small amount of money to compensate for any time lost on the failed transaction. Granted, if the buyer cancels the transaction due to an issue with the inspection or appraisal, they will get the earnest money back.

So, what is escrow in real estate, and who manages the escrow account? The point of the account is to ensure a neutral third party manages any money that’s exchanged at the beginning of the closing process. Who this third party is depends on where you are, as various states do this differently. A bank or real estate attorney can manage the escrow account in some areas. In others, the title company takes on this task. Either way, the money in the escrow account is only released to the seller once the home’s title is successfully transferred to the buyer.

Step 2: Figure Out Financing

As you look for more answers to questions like “what is escrow in real estate?” you’ll find out that a big part of the process is ensuring the buyer has the funds to purchase the property. Being pre-approved for a loan first can speed up this process, so encourage your clients to make this step before putting in an offer. This way, they can send their lender the home address they want to buy. And then, the lender can work out a reasonable faith estimate that tells them how much the total will be—including closing costs, interest rate, and the total amount buyers can borrow.

Before lenders create an estimate, they need to complete an appraisal of the house. This process determines how much the home is worth before letting buyers borrow money. After all, the bank doesn’t want to let buyers borrow $500,000 on a property that’s only worth $350,000. If the buyer stops making payments and forecloses on the house, the bank won’t get anywhere close to the amount they need to make back their money.

Your client will need to wait for the appraisal to come back before securing a loan. If the appraisal comes in at or slightly above the asking price, your client is one step closer to getting a home loan. But if it’s below the asking price, the bank will likely not lend your client the amount they requested. This may mean your client will have to pay more out of pocket at closing to reduce the loan amount or negotiate with the seller to bring down the price.

Step 3: Complete the Title Search

New real estate agents have a common question: “what is escrow in real estate, and how does the title search factor in?” The title search ensures that the house your buyers are purchasing belongs to the seller and no one else. This means the title search needs to come back with a clean title that doesn’t list anyone else as property owners. Otherwise, the buyer could spend money on a house that the seller doesn’t own, leaving your client without legal rights to the home.

This is why a title agency has a significant role in the escrow process. A title agent not only runs a title search but also sells title insurance to the buyer. Most lenders require buyers to buy lenders’ title insurance, as this protects the bank if there were title defects that the title search did not initially catch. But buyers should also purchase the owner’s title insurance to protect themselves if there are liens and other title defects on the house.

Step 4: Get a Home Inspection

Another task buyers need to do before taking ownership of the house is the inspection. So, what is escrow in real estate, and how does the home inspection fit in? Buyers need to pay for an inspection of the house to ensure no major unexpected issues that could cost them thousands of dollars to fix once they move in.

Of course, most homes will have a few defects. They might be minor, like some missing roof tiles, or they could be more prominent—like the water heater needs to be replaced soon. Either way, the buyer needs to know about these issues so they can ask the seller to fix them or reduce the price of the home. In extreme cases, buyers can back out of the sale if major issues–like foundation problems—are discovered during the home inspection. This is why the home inspection is a big part of escrow.

Step 5: Buy Home Insurance

Once buyers get the home inspection report back and see no unexpected problems, they’re almost done with the escrow process. The next step is to buy homeowner’s insurance to protect themselves if anything goes wrong with the home while they own it.

For example, if the house is ever damaged due to extreme weather, vandalism, or fire, homeowner’s insurance should pay to fix or rebuild the house. And if the homeowner’s belongings are stolen or damaged in a covered event, the insurance company will also pay for repairs and replacements. Encourage your clients to shop for an insurance policy from a company that offers the best coverage at reasonable rates.

Step 6: Complete the Final Walk-Through

If you’re still wondering, “what is escrow in real estate?” know that the final step is the walk-through right before closing day. This is when the buyer walks through the house one more time to ensure all repairs have been made and the house is in good shape before they get the keys.

After the walk-through, the buyer should be ready to attend closing day! At this point, you and your buyer will meet with a few other people—like the escrow agent, a real estate attorney, and sometimes even the seller—to sign paperwork and get the keys to the house. This is also when your client will pay closing costs.

As a real estate professional, you get to be there for your client every step of the way, from the start of the escrow process to the end. One of the best ways to make this process as seamless as possible is to help your clients find the fastest, more secure ways to pay, starting with their earnest money. Fortunately, you can point them toward, a secure digital platform that lets them send their earnest money deposit digitally instead of dealing with cashier’s checks or wire transfers.

They can use the same method to get a refund if they get their earnest money back. Plus, as a real estate agent, you can get paid your commission through! Schedule a demo today to learn more about our platform.