Escrow and your Mortgage Loan

An escrow account is used during property transactions to protect both the buyer and the seller. The contents of the escrow account are held in safekeeping by an escrow agent, and are released when the contract between the buyer and the seller is executed. This happens only when all the conditions of the contract are met.

The escrow account can be used to hold the following items:

• The buyer’s deposit
• Earnest money (a small deposit paid by the buyer as a show of good faith)
• The title to the property
• Title transfer documents that have been signed by the seller

After the escrow account has been created the buyer and seller have a certain amount of time to place these items in the account (the length of time is predetermined and is part of the contract). The deposit and earnest money are usually paid by cashier’s check or wire transfer to speed up the process. After all the items have been deposited, the buyer and seller have another predetermined period of time in which to fulfill contingencies of the contract. For example, there may be a contingency which stipulates that the seller must carry out some small repairs on the property; they will then use this time to do so.

Once the escrow account has been created and items have been deposited, the buyer and their lender will work on completing the mortgage approval process, if the buyer was not pre-approved for their mortgage (this is why having mortgage pre-approval makes closing much faster—most of the time taken up by the closing process is related to the buyer’s mortgage approval). This involves verifying the buyer’s income to make sure they can afford the mortgage, as well as verifying that they have enough cash for the deposit and closing costs for the transaction. The property that is changing hands will also be appraised, and the buyer’s mortgage documents will be delivered to the escrow agent after the mortgage contract is approved. The seller’s responsibilities include making sure that any contingent repairs are carried out, as well as making statutory disclosures such as environmental hazards associated with the property.

After all contingencies of the contract have been completed, escrow is closed and the escrow agent distributes items in the account to the relevant people—the buyer gets the title contract, and the seller gets the funds.

When this process has been completed, an escrow account can be used for another purpose. Essentially, it functions as a savings account into which the new owner deposits money to be used to pay insurance and property taxes. This money is collected by the mortgage lender and paid into the escrow account, and the lender then pays those bills as they become due. The lender may also require the owner to deposit up to two months worth of payments in advance to cover future increases in payments. Note that using an escrow account for this purpose is not required by law. It is, however, a convenient way of making payments on property taxes and insurance.