The time between agreeing on a price for the sale of a property and actually handing over the keys is an often-misunderstood period, sometimes known as escrow.
While most buyers and sellers are familiar with the concept of the escrow period, many are less familiar with what actually happens during this important fulcrum point for the real estate transaction – particularly, what happens “from contract to close.”
More often than not, buyers often think of escrow like a mysterious “black box” into which the deal is placed, only to emerge four or six weeks later for closing. We know that it’s easier to navigate the ups and downs of the entire real estate process when you understand what to expect. Let’s discuss what goes into escrow, and how a title company can help both buyers and sellers navigate the escrow process:
What Is an Escrow Account?
At its most broadly defined, escrow refers to a legal process in which a designated third party holds money or another financial asset on behalf of two or more other parties who are negotiating the terms of a transaction.
In a typical real estate transaction, the buyer’s earnest money – the money the buyer pays to confirm the intent to go forward with the sale – is deposited with a third party, which then distributes it according to the terms agreed to by the parties upon closing.
The amount of the earnest money payment can vary, but generally constitutes about one to five percent of the purchase price. (So for a purchase price of $300,000, a buyer might expect to deposit $3,000 to $15,000 in earnest money.)
In most cases, earnest money is delivered when the parties sign the initial purchase agreement. Once the earnest money is deposited with the escrow agent, the funds are held in the agent’s account until closing, when the deposit is applied to the buyer’s downpayment and closing costs. This is known as the escrow account.
What Happens During Escrow?
While the concept of the escrow account is relatively straightforward, it’s important to note that in a real estate deal the term “escrow” is also commonly used to refer to the time period between the acceptance of an offer and the final closing of the sale. This period is also sometimes called the “contract to close” period.
During this period, the buyer’s earnest money remains on deposit with the parties’ escrow agent while the parties finalize the terms and contingencies that precede the final closing.
During this window – the escrow period – the parties fulfill the terms of any contingencies in the purchase agreement. A contingency is a term or condition that must be satisfied before the purchase agreement becomes binding on the parties. Should the parties fail to fulfill one or more of these contingencies, the deal can fail without penalty to either party.
The typical purchase agreement will contain several standard contingencies, which may include:
- Clear Title Contingency: During the escrow period, the title company will perform a title search to ensure the buyer is receiving unencumbered title to the property. If a title search reveals unpaid taxes, a contractor’s lien, or any other type of claim against the property, the clear title contingency can allow the buyer to walk away from the sale.
- Attorney Review Contingency: In Illinois, both the buyer and seller typically have attorneys for any real estate transaction. The attorney review contingency provides for a five-day period, which can be extended by the parties, during which the negotiating attorneys coordinate the inspection and negotiate any necessary terms within the contract. This contingency is common in Illinois, and may also be included in real estate transactions in Wisconsin if attorneys are retained by either party.
- Inspection Contingency: During the escrow period, an inspector will examine the property’s interior and exterior for structural defects or problems with the property’s HVAC, electrical, plumbing, or other systems. Depending on the inspector’s findings, the parties can either remove the contingency, back out of the deal, or negotiate for repair work or credits to be offered by the seller. If attorneys are involved in the transaction, the attorney review and inspection contingencies generally run concurrently, and are coordinated together by the parties’ attorneys.
- Appraisal Contingency: Generally required in any transaction requiring a mortgage lender, an appraisal contingency protects the buyer’s lender – essentially, by requiring that the property be worth the amount of the mortgage the buyer is taking out.
- Financing Contingency: A financing or mortgage contingency provides that the sale is contingent upon the buyer’s ability to obtain financing. During this period, the lender’s underwriter will review all loan documents to make sure the buyer meets the lender’s requirements, as well as any other applicable requirements. Should the buyer fail to obtain a mortgage within the time specified, the buyer’s earnest money is returned and the deal falls through.
- Homeowner’s Insurance Contingency: The buyer’s lender will require the purchaser to have homeowner’s insurance in place prior to closing. This contingency protects the buyer in the event that the home is found to be uninsurable.
Once these conditions are satisfied or removed, the parties can move forward to close the transaction. During this period, your title company will work to ensure that the title is free and clear of encumbrances, often working behind the scenes to clear clouds on title that could threaten the deal.
Agents, attorneys, and the parties themselves will work through all of the contingencies and any details that need to be worked out before closing.
Are There Other Types Of Escrow Accounts?
As a homeowner, you may encounter other types of escrow accounts, which your title agent or real estate broker can talk you through. For example, the buyer’s mortgage lender may establish an escrow account to pay for the buyer’s portion of taxes and insurance. In such a situation, after closing, the lender would take a portion of the monthly mortgage payment and hold it in an escrow account until any tax and insurance payments are due.
The reason for this is that, while taxes and insurance are the homeowner’s responsibility, lenders can’t always be confident that homeowners will budget for those expenses properly – which can place the lender’s interest at risk. For example, if the homeowner fails to make homeowner’s insurance payments and the property suffers damage, that could leave it worth less than the amount of the mortgage. Similarly, a tax lien could force the sale of the home to satisfy the tax debt, leaving the lender only able to collect what’s left after the taxes are paid.
Landtrust Title: Your Partner for Results
When your real estate agent works with Landtrust Title, you get a partner for results. We do things differently than other title companies — whether it’s personalized support, convenient closing times that meet your schedule, or quick and easy payment methods ensuring everyone gets paid right away, our attention to detail will help ensure a smooth transaction. We’re obsessed with making your experience so seamless, you don’t even have to think about it. If you have questions about what to expect when your real estate deal closes, Landtrust Title Services can help. Please contact us today at customerservice@mylandtrust.com or by phone at 312.528.9210.