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In the real estate industry, the word escrow has several meanings. For example, the term might mean putting valuable real estate documents such as purchase agreements, title transfers or proof of earnest money deposits in an “escrow” account that is held by a third party. The term can also represent the closing of a real estate transaction. Escrow also represents borrowers paying a portion of their property taxes and insurance each month to their lenders who then hold the additional payments in an “escrow” account.

A Closer Look at Escrow and Real Estate

When borrowers make an offer to purchase a home, they will often provide an earnest money deposit that assures the seller they are serious about buying. The earnest money will then go to a third party that is neutral to the transaction. During the transaction, the third party will hold the deposit in an escrow account until the process is complete. Neither the seller nor the buyer can touch the funds until the deal closes.

Mortgage Companies and Escrow

Mortgage companies and lenders use escrow accounts to hold funds for the payment of property taxes or insurance. Borrowers who have escrow accounts with their lenders will pay additional money each month. When taxes and insurance payments are due, the lenders will use the money from the escrow accounts to make the payments. In most cases, lenders will require borrowers to pay 1/12th of the yearly property tax and insurance total each month.

The Importance of Escrow

The actual process of escrow in a real estate transaction varies by state. However, the common theme is escrow protects all parties from certain levels of risk. Escrow ensures all parties are making a good faith effort to close the transaction in a timely manner. For example, the escrow process protects sellers by proving the buyer has the financial resources to complete the purchase. Escrow also protects buyers by guaranteeing the seller actually owns the home and there are no liens or judgments on the title.

However, escrow does not guarantee that all real estate transactions will close. Several factors can cause the escrow process to fall apart. For example, a buyer may not qualify for the financing to purchase the property, or the home’s appraised value comes in lower than the requested loan amount. These are only a few factors that can affect the escrow process.