Understanding the Escrow Process When Buying a Home
Everything you need to know from earnest money until you close.
One of the most complicated (and expensive) purchases you’ll make is likely a home. The process of buying a home comes with a lot of paperwork and there are a number of steps you need to follow from the time you and a seller agree on a price and when you actually get the keys to the home.
As you move forward, you’ll have to make an escrow deposit and follow a set process. Here’s what you need to know about the entire escrow process when you buy a house.
1. Open an Account and Make Your Escrow Deposit
Escrow (in homebuying) is a term that covers all the steps between the time you and a seller agree on a price and when you actually take possession of the home. You’ll sign an agreement and then be required to send a good faith deposit—called earnest money—to an escrow account.
Your earnest money basically sends the message that you’re serious about the agreement. If you back out of the arrangement without just cause, the seller can keep the earnest money.
The earnest money also goes toward your down payment, so if you complete the transaction you’re not losing any money.
An escrow account is managed by a third party. It’s designed so that you and the seller can trust that the money will be accessible as needed. If you need to withdraw from the arrangement due to a valid reason, you don’t have to try to get the money back from the seller, and the seller is assured that they will get the funds when the terms of the agreement are fulfilled.
The escrow company will manage all the required closing documents and make sure the purchase agreement is followed by all parties. Additionally, the escrow company usually manages the actual closing and final documents.
In some cases, though, a lawyer handles all of these steps in what’s referred to as the “settlement” process. For homebuying, escrow and settlement can usually be used interchangeably—and sometimes it will even be called escrow settlement.
2. Home Appraisal
Your lender will want to make sure your home is worth the amount of the purchase price you agreed to. After all, the lender is the one putting up the money—they want to know that if they have to foreclose they’ll be protected. Normally, the buyer pays the cost of a home appraisal.
Make sure there’s a contingency clause related to the home appraisal. If you’re pre-approved for a loan, but the appraisal comes in low and the lender decides not to fund the loan after all, you could end up losing your escrow deposit if you’re not protected.
Request that the purchase agreement includes a clause that allows you to back out of the sale if the appraisal comes in below the purchase price. Otherwise, if you don’t want to lose your earnest money, you might have to convince the lender to go through with the loan by making a bigger down payment—or convince the seller to lower the purchase price to match the appraisal.
3. Finalize Your Financing
Now that you have an appraisal, you can finalize the amount of your loan. This will depend on your down payment, whether you roll closing costs into the loan and other factors. At this point, your lender should approve your loan amount and terms.
Realize, though, that you might be subject to other requirements throughout the process. If you own another home, you might be required to sell it before you can close escrow on the new home. This is known as a contingent sale.
Additionally, a lender might review your credit again as your closing date nears. If a lender detects red flags, even after initially approving your loan, it’s possible that they will change their decision—even the day before you’re set to close. Stay in close communication with your lender so you can provide additional documents in a timely manner. You don’t want to jeopardize the process.
Get a contingency in your purchase agreement that states that the lender has to fully approve the loan. That way, if your lender yanks funding at the last minute, you still have the option to back out of the transaction without losing your escrow deposit.
4. Review the Seller Disclosures
Before you move forward, it’s a good idea to carefully review seller disclosures. These are items the seller knows are likely to affect the property and its value. You can also look at building permits and check to see if there are natural disaster concerns, like tornadoes, mudslides, flooding, and earthquakes.
Part of the paperwork you sign during the homebuying process is to acknowledge and accept the disclosures. Depending on where you live, you might see the disclosures before you and the seller sign the purchase agreement. If you live in a place where you receive the disclosures after being in escrow, make sure your agreement includes a contingency clause allowing you to back out if the disclosures show something you find unacceptable. That way, you can protect your earnest money if you decide that there’s something especially disturbing in the disclosure paperwork.
Once you actually sign the disclosures, though, you’re acknowledging that they’re acceptable to you and you’ll take responsibility. If you try to back out of the home purchase based on these disclosures later, you could lose your escrow deposit.
5. Home Inspection
Another way to protect yourself—and your escrow deposit—is to pay for a home inspection. This is a cost that isn’t required, but it can be a good idea. A home inspection is designed to catch defects that could be dangerous or costly and that might not be readily observed.
Other inspections to consider, related to your home’s safety, sanitation and structural integrity might include:
- Pest inspection (termites, carpenter ants, rats, etc.)
- Environmental inspection (mold, asbestos, landfill contamination, etc.)
- Reports (flood, geologic, boundaries, etc.)
Once again, including a home inspection contingency can be a good way to protect your earnest money. Your agreement should state that major problems should be grounds for you to walk away from the purchase—and keep your deposit.
6. Insurance Purchases
Lenders expect you to purchase homeowners insurance as well as other types of insurance as necessary. For example, if you live in an area considered at a special risk for flooding, you might be required to purchase flood insurance. The idea is that your insurance will cover the cost of repairs or rebuilding, reducing the chance that you’ll default on your home loan in the event of a disaster.
Shop around for the best rate, and consider bundling your homeowners insurance with car insurance or life insurance for better deals.
While you’re going through the escrow process, you’ll also have to pay for a title company to run a report on the property. You want to make sure there aren’t liens and that the seller truly is entitled to sell the home. The purchase of title insurance is also important since it can provide protection in the event that something was missed during the title report.
Once again, making sure that your escrow deposit is protected is important. Your purchase agreement should refer to a clean title. If the title doesn’t come back clean, you want to be able to back out and take your earnest money with you.
8. Final Walk-Through
Before you close, you want to go through the home again. If you were promised certain appliances or fixtures, you want to make sure they’re in the home. Additionally, you can check to make sure some sort of damage hasn’t occurred to the property in the meantime. Generally, if you back out at this point, you’ll lose your escrow deposit. Only if some major damage can be seen, or if there is a major breach on the part of the seller will you be allowed to keep your earnest money if you leave.
9. Review Your Documents
At some point before the closing date, usually within a day or two, you’ll receive your final documents. Check to see that your final mortgage terms are in line with the loan estimate you signed earlier. Mostly, this is a chance for you to correct mistakes and have the documents updated if needed. At this point, it’s more about ensuring accuracy than backing out.
10. Close Escrow
Now it’s finally time to close on the home. There’s plenty of paperwork involved here as well, but once it’s done, everything moves forward. You’ll provide the rest of the money for your down payment to the escrow account and your lender will send the money to the account as well, so it can be disbursed to the seller’s own lender (to pay off their mortgage) or to the seller. A new deed with your name on it will be filed with the county and you’ll receive the keys to the home.
When the Escrow Account Remains Open
There are times when your escrow account doesn’t close. In some cases, you might be required to put a portion of your payment into an escrow account to cover the costs of homeowners insurance, property taxes, and mortgage insurance. This is a requirement if you’ve used a HUD-insured loan, such as an FHA loan, to purchase your home.
Each month, money is set aside in escrow and when bills are due, the money is paid. You might end up paying more or less in escrow each year, depending on what the actual bill ended up being. Double-check your paperwork so you understand if this continuing escrow arrangement is part of your mortgage agreement.
California Department of Real Estate. "Surviving the Real Estate "Escrow" Process in California: Important Things and Tips You Should Know, and Mistakes to Avoid," Pages 11-12. Accessed Nov. 25, 2019.
Commonwealth Land Title Insurance Company. "What Happens In Escrow Settlement?" Accessed Nov. 25, 2019.
OVM Financial. "What To Do After Having a Mortgage Loan Denied at Closing," Accessed Nov. 25, 2019.
NAR. "Land Use & Property Rights: Hazards & Disclosures," Accessed Nov. 25, 2019.
CFPB. "Buying a Home: Schedule a Home Inspection," Accessed Nov. 25, 2019.
FEMA. "Mortgage Lender Requiring Flood Insurance," Accessed Nov. 25, 2019.
California Department of Real Estate. "Surviving the Real Estate "Escrow" Process in California: Important Things and Tips You Should Know, and Mistakes to Avoid," Page 23. Accessed Nov. 25, 2019.
CFPB. "What Is Owner's Title Insurance?" Accessed Nov. 25, 2019.
CFPB. "What is a Loan Estimate?" Accessed Nov. 6, 2019.
HUD. "Administration of Insured Home Mortgages Handbook: Chapter 2: HUD Escrow and Mortgage Insurance Premium (MIP)" Page 1. Accessed Nov. 25, 2019.