What is Escrow?

If you’re new to the home buying process, the first few months can feel like information-overload. From navigating the market and pricing, to learning new financial terms, buying a home can often feel like learning a foreign language. And one of those new words you’ll have to learn is escrow.

You’ve likely heard the term, but if you aren’t really sure what escrow means (or how it works), you’re not alone. We’ve received hundreds of questions from readers like you asking what they need to know about escrow, so the Finance Opinion team researched the facts and broke it all down for you in this post. 

Grab a cup of coffee and keep reading – you’re about to be an escrow-pro! 

What is Escrow?

Escrow is a legal arrangement in which a third party temporarily holds an asset (this can be money or property) on behalf of two other parties until a specific, agreed upon condition has been met. For example, in the homebuying process, escrow occurs when the buyer and seller are ready to move forward with the sale, but waiting for the fulfillment of a purchase agreement. 

However, homes aren’t the only assets that can be held in escrow. Escrow can be used for money, securities, funds, or any other asset involving a transaction and agreement between two parties. 

In order for an asset to be “in escrow,” it must be deposited into a specific escrow account to be managed by a third party until the agreed upon conditions are met. Depending on the reason for escrow, this third party agent could be a real estate title company, a bank or other financial institution, or a private individual entrusted with the role. Either way, it should be a neutral third party everyone can trust to help manage the transaction.

The Benefits of Escrow

While it can seem strange to move your money into a temporary holding account, escrow offers a multitude of benefits to all parties involved, especially in the homebuying process. 

As homebuyer.com suggests, placing all contracts, terms, and funds into the hands of a third party while under contract offers security to both the buyer and seller, because it ensures all contract requirements will be met and agreed upon before any money is paid.

Whatsmore, should the escrow fall through, funds can be protected and returned to either party. However, there are contingencies to that, which brings us to our final point…

What Does it Mean When Escrow “Falls Through?”

While escrow is usually the final stage of a sale, it can fail. The term “falls through” can sound pretty scary if your cash is involved, but escrow failures can be pretty common. 

For example, when a home falls out of escrow, it means something went wrong with the terms of the contract and/or transaction. Reasons can include a false pre-approval for a home buyer, a home inspection gone wrong, issues with the property title, and even a buyer backing out. Whatever the reason, the sale of the property becomes void, and the escrow “falls through.”

In the case of escrow failing, it’s critical to know the contingencies of your specific escrow agreement. With a contingency clause, most homebuyers are protected in cases like a failed inspection or appraisal, and they can get their escrow cash back. However, if a buyer backs out from a sale or has some other emergency pop up where they can no longer move forward with the transaction, they could lose your escrow cash, and even have to front a cancellation fee. 

Remember, as with any financial transaction, it’s important to do your research before moving forward with anything new to you. If you need help better understanding your specific escrow clauses and contingencies, chat with your escrow agent or a trusted financial advisor.

LEGAL DISCLAIMER

The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, we advise you to consult with a licensed advisor.