What is Escrow? All You Need to Know
Do you fear investing in real estate to avoid losing your hard-earned cash to con sellers? Well, no one loves to lose their money to cons, not even a single coin.
Or are you a property seller but let opportunities slip because you don’t want to risk your property to cons? So, what do you do to secure your funds or properties?
I’ll give you the correct answer, and henceforth, you’ll be free to do transactions worth millions, if not billions, of money.
This post clearly explains escrow’s meaning and how it can help you close real estate deals.
An Escrow is a third party who holds money for two parties engaging in a business transaction. Once the seller agrees on the final price with the buyer, they request the buyer to deposit the funds in an escrow account.
Escrow is usually a legalised arrangement that foresees the success of transactions. Escrow returns the money to the buyer if the seller doesn’t meet the sales agreement requirements.
Escrow also holds homeowner’s mortgage repayment funds. However, this is usually an agreement between the lender and the borrower (homebuyer).
How does Escrow Operate?
For Property Buyers
If you are buying a home, apart from proof of funds letter, the seller will request you to deposit some funds in escrow to serve as a down payment. This will act as good faith, and you will show the seller that you are willing to buy their property.
Once you complete signing the home transfer documents, you are free to release the funds to the seller.
However, that’s not always the case if you find some wrong things that need the seller to fix. Escrow holds the buyer’s funds until the seller does what they ought to do if this is the case.
For Taxes and Insurance
This escrow account works for the new homeowner and the mortgage lender. After buying the property, the lender opens an escrow account where they’ll take portions of your monthly mortgage repayments to pay your taxes and insurance.
The funds stay in escrow until tax and insurance payments are due. However, the tax and insurance amount can change annually due to adjustments caused by things like inflation.
When the tax and insurance payments increase, the lender requests you to add more funds to your monthly mortgage payments. On the other hand, when the taxes and insurance reduces, the lender gives you an escrow refund.
Who Manages Escrow Accounts?
It’s a third party responsible for releasing funds to the right owner, where the buyer if the sales agreement is void or the seller when the agreement is signed.
In Kenya, we have Escrow Kenya that can help you in making big purchases and sales.
An escrow agent manages the account if you don’t need a mortgage. In comparison, a mortgage lender manages the account if you are using a loan to buy the property.
During mortgage repayment, a mortgage servicer/lender manages the escrow account until you completely pay off your loan.
They will be responsible for depositing the right amount for taxes and insurance in the escrow account. They are also responsible for all payments.
Benefits of Escrow Accounts
- For property buyers
An escrow account will protect you from potential scams. Once you feel something is not adding up about the property you are about to buy, you can leave the contract and get your deposit back.
- For property sellers
An escrow account helps buyers to pay taxes and insurance without much pressure. The lender gets that from the lump sum mortgage payment and sets apart money for taxes and insurance.
In addition, the mortgage servicer keeps all records about when tax or insurance premium is due. So less stress on your side.
- For lenders
Lenders are in the first line to ensure you pay all taxes and insurance premiums concerning borrowers’ homes. And escrow helps them manage that.
If the buyer doesnâ€™t pay the property taxes, KRA will come after the property, and the lender will lose. In addition, if buyers don’t pay the insurance and anything happens to the property, the lender still loses.
So escrow helps them avoid such inconveniences.
Disadvantages of Escrow Accounts
- The mortgage repayment has a higher monthly instalment due to included taxes and insurance. So the buyer will have to put in more money.
- Wrong tax and insurance estimates that are subject to annual changes can get the buyer off-guard, especially if it’s an increase.
Always consider using escrow accounts when selling or buying property. That will save you from unnecessary damages caused if one party breaches the sales agreement.
Frequently Asked Questions
- Is an escrow account safe for buyers?
Yes. Legitimate escrow accounts should protect buyers from scammers. Buyers cannot lose money to scammers masquadarring as property sellers. Once a buyer notices some fishy details, they can pull out from the sales agreement and get their money back.
- What happens to the escrow balance after repaying the mortgage completely?
The mortgage lender issues an escrow refund. So you won’t lose your money.