Escrow is a state-specific process where buyers and sellers deposit documents and funds with a neutral third-party until contract conditions are met. This is commonly used in real estate transactions. After opening an escrow account, the buyer’s earnest money is deposited and parties work to meet contract requirements with oversight from the third-party escrow company.
If you’re buying real estate or other property, it’s important to understand your rights under the purchase agreement. If you need help reviewing the purchase agreement and evaluating contract contingencies, check out Rocket Lawyer. Their team of legal professionals can help with document review and answer your questions about the escrow process. Click here for more information.
How Escrow Works
The escrow process opens when a purchase agreement is signed by the buyer and seller of real estate or other property. Typically, the appropriate escrow company is named in the purchase agreement. After escrow opens, the buyer’s real estate agent will contact the escrow company to open an escrow account where the parties deposit earnest money, loan proceeds, and relevant documents like the real estate contract.
Once the account is open and the appropriate documents and buyer’s deposit have been entered into the account, the due diligence period begins. The due diligence period is when the parties are responsible for fulfilling contract requirements like inspections, appraisals, financing, and repairs. The length of the due diligence period is described in the real estate contract.
If a buyer breaks a contract during the due diligence period because a contract requirement isn’t met, the escrow company returns the earnest money to the buyer. Alternatively, if a deal falls apart after due diligence or for reasons not in the contract, earnest money is released to the seller. When all contract requirements are met and the transaction closes, the escrow company releases the deed to the buyer and disperses loan money to the seller.
How to Complete the Escrow Process in 8 Steps
The escrow process varies by state but generally involves the buyer’s representative opening an escrow account, depositing earnest money into the account, completing due diligence, preparing financing and closing documents, and then putting the loan money into the escrow account. Once transfer documents are recorded, the escrow funds are dispersed to the seller, real estate agents, and other parties according to the terms of the contract.
To complete the escrow process, agents and buyers/sellers follow these eight steps:
1. Execute the Purchase Agreement
The escrow process, or period, begins when a seller accepts a buyer’s offer to purchase a house, business, or other property. The purchase agreement for the property is drafted by the seller’s agent and typically identifies an escrow company to handle the transaction and specifies the amount of earnest money the buyer must place in escrow. This process is considered “open”—or begins—once the purchase agreement is signed by both parties.
2. Open an Escrow Account
After the purchase agreement is signed, the agent or broker handling the sale contact the escrow company or title company to open an escrow account. To do so, the escrow company typically needs the buyer and seller’s name and address, the property description and address, and the purchase price but required information depends on the sale. The company also needs to know how much of a deposit, or earnest money, will be held in the account.
Additional information the escrow company requests for a real estate transaction may include:
- Termite report information for the property being sold, including who will perform the inspection
- Financing information from the lending institution
- Whether the property will be rented and, if so, for how much
- A list of personal property involved in the sale
If you’re buying or selling a home without an agent or broker, there are several other ways to find an escrow company. First, contact your bank to see if they provide escrow services. If you’re using a title company for the property transaction, ask them if they can create an escrow account for you. If neither of these options is available, contact a local attorney and ask for recommendations.
3. Place Earnest Money & Documents in Escrow
In transactions handled by an escrow company, earnest money doesn’t go directly to the seller. Instead, it’s held by an impartial third party until the deal is closed. This way, both parties are guaranteed to get what is due under the contract at the same time. After the escrow company opens an account, your real estate agent will request a cashier’s check or bank transfer for the earnest money agreed to in the purchase agreement to deposit in the escrow account.
After escrow is opened, parties should also provide the escrow company a copy of the purchase contract and other documents and written instructions for how the transaction should proceed. This ensures the escrow company understands all of the contract requirements that must be met before releasing the deed to the buyer and releasing loan disbursements to the seller. It also lets the escrow company know if a buyer may break the contract and retain their deposit.
Certain contract requirements, otherwise known as contingencies, must be met for a transaction to close. Common contingencies an escrow company monitors include the property appraising for a certain value and the buyer obtaining home and flood insurance. Real estate contracts may also be contingent on inspections coming back with minimal concerns, sellers completing required repairs, and other issues revealed or addressed during the due diligence period.
4. Conduct Due Diligence
After the earnest money and contract have been placed in escrow, the homebuyer should complete due diligence on the purchase. The due diligence period is defined in the purchase agreement and is the time in which the home should be inspected and appraised. If you are buying a business, this is the period during which you should examine the company’s books or conduct other business valuations.
If you’re using financing to purchase real estate, this period also includes finalizing the source of your loan, which may require an appraisal and various inspections to confirm the value of the property. This is critical because the property is the loan collateral that protects the bank’s interest. Once the appraisal, inspection reports, and loan documents are completed during due diligence, the buyer’s agent should forward them to the escrow company.
5. Order a Title Search & Purchase Title Insurance
As part of the due diligence process, an attorney or title company also performs a title search to evaluate whether liens exist on the property. If the title is clear, the title company drafts and issues a title commitment and deed transfer paperwork is prepared. This is also the point at which a closing date is scheduled and confirmed with involved parties.
If you’re buying a business, this is the time to conduct a Uniform Commercial Code (UCC) search and lien search to determine whether the seller or company are subject to any UCC-1 financing statements or other liens.
6. Prepare for Closing
If all of the contract contingencies have been met or waived by the end of the due diligence period, an attorney, title company, or escrow company prepares closing documents. Depending on the type of sale, these documents may include a HUD-1 form to finalize loan terms and documents. In a real estate transaction, the buyer may also perform a final walkthrough to confirm the property condition hasn’t worsened and to ensure necessary repairs are complete.
7. Deposit Outstanding Purchase Funds
Once financing terms and closing documents are finalized, the escrow company calculates the final amount the buyer must pay at closing and the loan proceeds are deposited into the escrow account. This amount is based on closing costs as well as factors like property taxes and utilities paid by the seller. This is also the stage when the seller’s agent deposits the deed or other ownership documents into the escrow account.
This stage can be completed by presenting the closing agent a cashier’s check, arranging a bank transfer, or depositing loan proceeds—as is often the case with the purchase of residential real estate. If a business is being sold, the purchase may be completed with the deposit of funds by a lender or through execution of seller financing documents.
8. Close Escrow
Escrow is considered closed either after a contract has been canceled and deposits returned or when money and property have exchanged hands and the transaction is complete. After this final stage, a new owner may take possession of the business or property that’s the subject of the purchase contract.
In a real estate transaction, this is typically the stage where the new property owner takes possession of the property. If the contract is for the purchase of a business, this is when a new owner takes control of the business and takes responsibility for its operation.
Escrow fees are the portion of closing costs covering preparation of closing paperwork, exchange of funds, and deed recording. This includes a flat fee or a percentage of the purchase price—typically between 1% to 2%. These fees are commonly shared equally by the buyer and seller and depend on the escrow company you use.
Frequently Asked Questions (FAQs)
What does it mean to be in escrow?
In real estate, being in escrow means the buyer and seller have entered into a purchase agreement. Once escrow opens, the buyer deposits their earnest money with the escrow company identified in the purchase agreement. The escrow officer will also collect relevant documents, contracts, and other instructions for how the transaction will proceed. Escrow closes when the buyer’s deed is recorded, and the loan proceeds are released to the seller.
How much is escrow on a house?
Escrow on a house typically depends on the escrow company you use and the purchase price of the home. On average, escrow fees cost between 1% to 2% of the final purchase price. Based on national median home values, this equals approximately $2,000 to $4,000 on average.
What happens to money in escrow if buyer backs out?
If a buyer breaks a contract after the due diligence period ends or for a reason not included in contract contingencies, the earnest money deposit is transferred to the seller. However, if the contract falls apart because a party is unable to meet a contract requirement within the due diligence period, the earnest money is returned to the buyer.
If you’re buying or selling a home, you’ll likely use an escrow company to act as a third-party that protects each party’s interests during the transaction. After an offer to buy property is accepted by the seller, escrow opens, and the earnest money is deposited in an escrow account. The escrow agent then holds the deposit and relevant documents until contract contingencies are met.
Real estate transactions—including ones that involve escrow—can be complicated and it can be difficult to understand your rights and responsibilities under a purchase agreement. Contact Rocket Lawyer for help reviewing transactions documents and understanding how the escrow process will affect the sale. Click here for more information.