What is Meaning And Significance of Escrow in Real Estate.

Grasping The Meaning of The Term Escrow in Real Estate

August 27th, 2024

In Canada, if you are buying or selling a home, there’s a high probability of encountering the term escrow. Although they are similar, there are two different types of escrow in real estate. So, it is likely that you would be unable to comprehend its meaning. If that is the case, then you have reached the right destination. In this blog, we will explain the term escrow, its meaning in real estate, and how it is different for a property buyer, seller and the usual property owner.

Table of Contents

Comprehending the Meaning of the Term Escrow

The term escrow in real estate is the method of placing deeds, money, documents or other assets in a 3rd party holding account. The stated commodities will remain in this account until the agreed sets of conditions and obligations have been satisfied by the involved parties. Post this; the goods will be shifted to the final beneficiaries. The escrow is created in a way that prevents scams and fraud. These are especially common in high-value transactions, like property.

Difference Between Escrow and Mortgage Escrow Accounts

Before discussing the working of escrow, let us first understand the two different types of escrows in real estate.

- The first escrow is used in the course of the purchase process. In this escrow, the buyer, as well as the seller, would be putting things into escrow. These things are generally the funds from the buyer and deeds and other documents from the seller.

- The second escrow means a mortgage escrow account. This is utilised by house owners who have taken out a mortgage and their lenders.

How Does Escrow Works in a Real Estate Transaction?

It is a known fact that when you buy or sell a house, the procedure is very complicated. It is also an expensive process for a regular person. For this matter, escrow makes the process easy and lowers the risks. It acts as a guardian for the seller and buyer. In general, the most usual assets that are kept in escrow throughout the sale of property are:

- Earnest money deposit
- Down payment
- Finance approval letter
- Property deeds
- Home inspection report
- Title checks

When you compare escrow with sending the funds directly to the seller, escrow is a more secure method. It is a safe process through which the buyer can easily send large amounts of money needed to make an offer on a property. This is because, in escrow, there is no risk of the seller absconding with your money. Similarly, it provides an assurance to the seller that the buyer is genuinely interested in buying the house before they remove their home from the market listing.

The documents, funds and assets are then placed in escrow. It is done till the time all the formalities have been completed.

What is the Typical Escrow Timeline?

Now that you have a basic understanding of escrow and its types let us have a look at the timeline of escrow.

The Opening of Escrow

After the seller accepts the buyer’s offer, the two parties are obligated to sign a purchase agreement. The agreement lists all the necessary conditions that must be fulfilled before the conclusion of the sale. Post this, the buyer and seller have to concur on a reliable escrow service that will be used. This can be done with the aid of the two parties’ real estate agents. The buyer opens an escrow account when he/she wants to put his/her money deposit in it. After the completion of the transfer, the seller is usually supposed to remove his/her house from the market listing.

Seller and Buyer Carry Out Their Obligations

This phase varies due to the incidences set forth in the purchase agreement. Although, the buyer has some common responsibilities after he/she pays the required money deposit. These are as follows:

- Send down payment funds to the escrow account.
- Provide proof of financing, such as an approval letter from a lender.

Meanwhile, the seller’s responsibilities include:

- Providing access for a home inspection and putting the report into escrow
- Make any agreed-upon repairs
- Place property deeds into escrow
- Complete a title search on the property
Conclusion of Escrow

The escrow agent handles the account, so after he/she is satisfied that both parties have met the commitments, they would deliver the capital to the seller and property deeds and any other applicable documents to the buyer. Fees for other 3rd parties, like layers, real estate agents and the escrow service, could be compensated directly via the escrow.

In case the conditions are not fulfilled and the sales are aborted, the applicable items are given back to the suitable pirates. The escrow fees are not included in this matter.

Cost of the Escrow Service and the Person Responsible for the Payment

It is presumed that the person is supposed to pay 1% to 2% worth of the property’s sale price. Usually, this fee is added to the closing costs. It is generally divided equally between the buyer and seller. Although, anyone from the buyer or seller can utilise this fee to bargain.

Escrow on a Mortgage: An Overview

Although now you have an understanding of the working of an escrow and its implications during the buying process/ selling process of a property, you might still have a few doubts. You could have a doubt about mortgage escrow. In case you are wondering how it works, don’t worry. We’ve got you covered. A mortgage on an escrow is a type of escrow account set up by your lender. It is created when you take out a mortgage.

Comprehending Escrow Payment and the Way it Works

When you make a mortgage payment, a small portion of your money is kept in your mortgage escrow account. When the year ends, your fund from this account is utilised to finance property taxes and a home insurance policy. This method is followed predominantly in the United States. Although, the term escrow in Canada is rarely used. Here, it is known as a property tax account. However, unlike the States, escrow account in Canada is only utilised to finance property taxes.

The escrow remittance is naturally added to your mortgage and is evaluated by your lender. It is important to note that it fluctuates every month, especially during the initial years. As a result, your mortgage payments will also rise and fall from month to month. This could be an issue in creating your budget with precision.

As such, they can rise and fall from month to month, especially in the first few years. Consequently, your mortgage payments will fluctuate, making it difficult to budget accurately. Although, your escrow balance would be sufficient to finance all the necessary payments at the year closing. But, if you fail to meet the payments, you will have to pay the rest of the amount from your own pocket. The plus point of this account is that the extra amount is given back to you.

Require an Escrow Account for Your Mortgage?

After reading everything necessary about the term ‘escrow’, you might wonder whether it is necessary for you to have an escrow account for your mortgage or not. Well, in the United States of America, you are supposed to have an escrow account for this purpose. Although, at times, you can pay the property tax and insurance payments from your own pocket. Although this reduces your per-month mortgage payments, you would need to finance a round-sum amount at the closing of every year.

You would generally need a good credit profile for a standard loan in the United States of America. You will be required to significantly pay no less than 20% down payment to steer clear from mortgage escrow. FHA (Federal Housing Administration) loans would require an escrow account at all times. The VA (Department of Veteran Affairs) loans customarily need a strong credit score along with a 10% down payment. You must note that a mortgage escrow account in Canada is generally not compulsory.

Summing Up

It is evident that having a mortgage escrow account is not mandatory in Canada. However, the escrow account has many advantages that could benefit you. Now that you are aware of the term escrow in real estate let us see its benefits:

- Meeting the property tax payment/ insurance deadlines: When you have an escrow account, you will always pay your property tax or insurance on time. Since you would not be a defaulter, you would not have to pay hefty fines. This will also help you avoid the worst-case scenario of the foreclosure of your house by the lender. Thus, we can say that with the help of an escrow account, these issues would not worry you.
- Lay out the cost for the whole year: You would find it difficult to manage one big lump sum every year. Therefore, it will be easy to lay out costs throughout the year. For this, you just have to add it to your mortgage payments.
- Security of the lender’s investment: Lender would rather want you to be in possession of mortgage escrow. They prefer it because in case your house gets affected by a disaster and you fail to pay your insurance leaving your house uninsured. The escrow account will help you avoid having liens on your damaged property.

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Frequently Asked Questions (FAQs)

Is escrow available in Canada?

Yes, apart from traditional escrow services in Canada, you can find online escrow services as well. You can open an escrow account in Canada through either of the service providers.

How is escrow done?

To open an escrow account, both parties (buyer and seller) have to submit documents, written instructions, and funds with a neutral 3rd party till all the mandatory conditions are met.