Escrow refers to a financial arrangement where a third party holds and regulates the payment of funds required for two parties involved in a transaction. It helps make transactions more secure by keeping the payment in a secure escrow account which is only released when all of the terms of an agreement are fulfilled as overseen by the escrow company.
Thank you for reading this post, don't forget to subscribe!Escrow is most commonly used in real estate transactions but is also used in other contexts where secure payments are necessary, such as in online transactions or trade agreements.
Escrow reduces the risk of fraud by acting as a neutral third party that ensures that the buyer and seller meet their respective obligations before any money changes hands. It provides an element of trust and security, making transactions safer for all parties involved.
Here’s How Escrow Typically Works:
- Agreement: Both buyer and seller agree to the terms of the transaction and decide to use escrow to ensure its secure completion.
- Buyer Pays Escrow: The buyer deposits the funds with the escrow service. The escrow service holds the money until all the conditions of the agreement are met.
- Seller Provides Goods or Services: The seller delivers the property, goods, or services to the buyer as agreed. In real estate, this often involves transferring the title.
- Fulfillment Verification: The escrow service verifies that all agreed-upon conditions have been met. This might involve confirming the receipt of goods, services, or legal documents like property deeds.
- Release of Funds: Once the escrow service is satisfied that everything is in order, it releases the funds to the seller. In real estate, this is typically done at "closing," where all relevant documents are signed and exchanged.
- Transaction Complete: The transaction between buyer and seller is completed, with both parties having assurance from the escrow process that their interests were protected.
What's the difference between close of escrow and closing date?
When you're first talking to your agent about your timeline for completing the sale, you're likely going to identify two key dates: 1, your preferred closing day, and 2, the ideal close of escrow. The latter is just one part of the closing process, and it tends to be a lot more flexible. It only refers to the time when both the buyer and the seller have fulfilled their part of the agreement, such as passing appraisal and inspection checks, putting down a deposit, and acquiring pre-approval loan documents. This may or may not happen on the actual agreed date, as you might exchange all the necessary documents way ahead of the title exchange, automatically closing the escrow.
Generally speaking, you can expect this entire process to last between 30 and 50 days. You should be communicating with your buyer and agent throughout this period to ensure all key deadlines are met and that you have a clear idea of when the purchase agreement can be fulfilled!
Your close of escrow checklist
Once you have a rough idea of the closing timeline, it's time to get all your paperwork in check and proceed with the closing! Here's a handy checklist of what both you and your buyer will be expected to do during this time, and a few tips on how to make this process faster and smoother.
Let the buyer deposit in the escrow account
Both parties are going to need an escrow account to hold the buyer's funds until the purchase agreement is fulfilled, so the first step after finding an escrow company to work with will be to wait for your buyer to deposit the assets in the newly-opened account. A dedicated escrow agent will collect your buyer's earnest money deposit and act as the neutral third party until closing day, when the money is finally released and paid to your account. This process can be overseen by both an escrow company or an attorney identified as the escrow agent, depending on where you're based.
Obtain a title insurance
Now, with the help of your agent, you're going to dive into some paperwork yourself by ordering a title search, which is essentially a review of all public records available confirming that you are the legal owner of the property you're selling. It might seem like an unnecessary step at first, but any unknown claims made against your property could make the deal fall through or considerably delay closing!
Obtaining title insurance beforehand can make a huge difference and protect you from any unseen claims or judgments, and when it comes to your buyer and their lender, title insurance is required for the sale to go forward. You can talk to your real estate agents about the pros and cons of obtaining a different type of title insurance as a seller, also known as owner's title insurance, to decrease the chances of financial loss for both parties involved.
Complete the lender's appraisal and inspections
At this point, you might have already completed all necessary appraisals and inspections prior to working with a title company, or you might still be waiting for one last pest inspection. Whatever the case might be, you have to make sure you have cleared all contingencies in the sale contract before going ahead with the closing!
While an inspection will typically examine the safety and functionality of the home, including electrical faults, water damage, and even minor issues like leaky faucets and faulty windows, the lender's appraisal will determine the market value of your home. This is why the latter procedure is so crucial for the closing to go ahead as expected: If the appraised value of your property is lower than the loan amount, it might halt the selling process altogether and force you to go back to negotiating your price! If all contingencies have been met, both parties will move onto the review stage, but if your inspection and appraisal fail to satisfy the agreement, this might be where the journey ends.
Review all closing documents
Next, your buyer and their agent will review the documents you have provided, including all seller's disclosures and all title documentation. At the same time, you will also be reviewing the buyer's documentation with your closing agent, such as mortgage loan approval documents, the report from your appraisal, and inspection reports. Review all documents carefully on your end and make sure to send an accurate HUD-1 form to your buyer at least one day before closing, detailing all closing costs for the sale.
The final walk-through inspection
More of a formality than anything else, the final inspection takes place the day before, or in some cases, even on the day of the closing. The buyer and their agent will visit the property to verify that all is in working order, that all required repairs have been made, that all rooms are clean and free of any new damage, and that there are no extra items left behind. If the buyer discovers anything problematic during this final visit, you’ll need to address it promptly or risk the closing being delayed, sometimes even dramatically so.
Cancel all home services and utilities
Don't forget to cancel all utilities in your name before you give your keys and title to a new owner! While canceling all home services before you have an official closing date is strongly discouraged, you should try to contact your home's utility providers at least 48 hours before the change of owners, providing them with your new address. If you're worried you might forget something, you can count on us to provide a list of useful numbers for the termination of home services and utilities after the closing occurs.
Finalize the sale and close
With all documents in order, the time has finally come to finalize the sale, exchange keys, and receive your check! The very end of your close of escrow will usually take place in the office of your escrow officer, and you won't need to bring much with you to make the deal official. A government-issued photo ID, the keys to the property, and any outstanding documents your agent instructs you to bring, such as proof of completed repairs, will suffice.
The closing agent will provide all parties involved with a settlement statement, which summarizes and details all the financial transactions enacted in the process. The buyer will first sign this statement, then you, then finally the closing agent will sign as well to certify the accuracy of the figures. If you are unable to attend the scheduled closing, then you'll be happy to know that arrangements can be made depending on the circumstances and the notice you give your agents!
Once the paperwork is signed, you will receive confirmation that the escrow funds are being transferred, and as the seller, you will also get a settlement statement breaking down the purchase price, the closing costs incurred, and your net proceeds. Needless to say, the last step is the best step: Your buyer will finally take possession of the property and you are going to get paid! The possession process will take place on the same day as the closing of escrow.
In terms of how you're going to receive your funds from the transaction, you can choose to either have them wired electronically to an account or get a check issued to you at the time of closing.
Real Estate Escrow Example: How Escrow Works When Buying Property
Let's imagine a scenario where Sarah and John are interested in buying a home that is listed by Mr. Thompson for $300,000.
- Agreement on Sale: Sarah and John find Mr. Thompson's home appealing and agree to the purchase price of $300,000. They sign a purchase agreement that outlines the terms, including a requirement to use an escrow service to handle the transaction to ensure security and compliance with real estate escrow account rules.
- Opening an Escrow Account: The real estate agent assists Sarah and John in setting up an escrow account with a reputable escrow company. As per the agreement, Sarah and John are required to make an initial escrow payment of $15,000 as a deposit, which demonstrates their commitment to the purchase.
- Depositing Funds: Sarah and John transfer the $15,000 into the escrow account. The escrow company confirms receipt of the funds, and the money is now legally bound by real estate escrow account rules, which ensure it cannot be released until the conditions of the purchase agreement are fully met.
- Inspection and Appraisal: While the funds are held in escrow, the home undergoes an inspection and appraisal, which are necessary for Sarah and John’s mortgage lender. These steps are important to confirm the home is worth the selling price and is in good condition.
- Mortgage Approval: Concurrently, Sarah and John finalize their mortgage arrangements with their lender. Once approved, their lender prepares to transfer the remaining amount of $285,000 to the escrow account.
- Closing the Deal: All conditions outlined in the purchase agreement have been met: the inspection and appraisal are satisfactory, the mortgage is finalized, and no legal impediments to the sale exist. The escrow company then schedules a closing date.
- Finalizing Transaction: On the closing day, Sarah and John sign the final paperwork, and the escrow company releases the total amount of $300,000 from the escrow account to Mr. Thompson. Additionally, the escrow company ensures that the property title is officially transferred from Mr. Thompson to Sarah and John, marking the completion of the transaction.
- Conclusion of Escrow: With the transfer of funds and title complete, the escrow account is closed. Sarah and John now own the home, and Mr. Thompson has received his payment, with all parties assured that the transaction was conducted fairly and securely, adhering to all necessary legal and financial protocols.
This example illustrates how an escrow system adds a layer of security and trust to real estate transactions, ensuring that all funds are appropriately handled according to strict guidelines and only disbursed when every condition of the agreement is satisfactorily met.
The Short-Term Shop Will Help You Navigate The Escrow Process
Just like any other real estate transaction, buying short-term rental properties can be quite a challenge without escrow. The process reduces any kinks that might occur in the sales or buying process. However, escrow doesn’t always guarantee a successful transaction. It has to be managed.
The Short Term Shop helps investors buy, sell, and manage short-term rental properties for purposes of investment. We’ll manage the entire escrow process for you. If you have any questions or concerns about the transaction process, schedule a call with a consultant from The Short Term Shop today.
