What Is An Escrow Company And What Do They Do?

Understanding what an escrow company is will be an important part of any real estate transaction

Learning what is an escrow company and what they do likely won’t be the first thing that comes to mind for a homeowner selling their home. From putting the property on the market to considering their next move, there are many aspects of selling one’s property that may take center stage. Despite this, however, understanding what an escrow company is and what they do for both sellers and buyers is a pivotal aspect of the property selling process.

Defining ‘Escrow’

There are two things that ‘escrow’ can technically mean. The first, and what this article refers to when evaluating what is an escrow company, is a third party organization in a real estate transaction. The escrow company handles the financial exchange between the buyer and seller, and distributes money as instructed.

The second definition of ‘escrow’ is in relation to an escrow account. It’s an account in which a homeowner may have their property taxes and insurance payments included in their mortgage payment. In this case, the lender will ensure that property taxes will be paid to the local county on behalf of the homeowner every six months. They will also make sure that insurance payments are paid to the insurance provider. This post will focus on the first of the two definitions and answer the questions: what is an escrow company, and what do they do for homebuyers and sellers?

A homeowner will always have closing costs to pay in the final stages of selling their home. The greatest of these expenses is the real estate commission to both the listing agent and the buyer’s agent. But there are additional things to consider. Other costs include city and county transfer tax, title insurance, a few smaller, miscellaneous fees such as recording and wiring fees, and of course, escrow fees.

What are Closing Costs?

What exactly are all of these other various closing costs that a seller will need to pay? County transfer tax refers to the tax charged by a county when real estate is sold and transfers to another owner. The amount of this tax that a seller will pay depends on location. In Santa Clara County, (the majority of Silicon Valley), the tax rate is $1.10 for every $1,000 of the sales price. In San Francisco County, the tax ranges from $6.80 to $7.50 per every $1,000 of the sales price.

City transfer tax, on the other hand, is a similar tax that homeowners pay to the city (rather than the county) where the property is. It is not in effect everywhere. San Jose, Mountain View and Palo Alto all have a city tax. The other cities in the Silicon Valley area (as well as San Francisco) do not.

Title insurance protects the parties involved in a real estate transaction from financial loss due to defects from title. The specifics vary by country. In Santa Clara, the seller pays for the buyer’s title insurance policy while the buyer pays for the lender’s policy. Through this distribution, all parties will have protection from any potential loss in the transfer of property from the seller to the buyer.

From the buyer’s perspective, there are many fees that they will need to consider. These include lender fees, third party fees, pre-paid items and any necessary interest rate adjustments. They also include escrow fees.

What is an Escrow Company?

With all of these various fees and costs, where does an escrow company come into all of this? Simply put, escrow is the transfer of funds or a deed from one party to another after an agreed upon event has been completed or particular condition has been met.

Buyers and sellers will want to know that no funds will be transferred or deposited until all of their respective terms have been met. For all of the previously mentioned transactions involved in the closing, a third party escrow officer will be assigned to handle the transfer of large sums of money from one party to another. This will happen only upon meeting all of the pre-determined conditions.

Escrow is essentially a neutral party involved at the end of a real estate transaction. They are responsible for making sure that neither the buyer nor the seller receives a property or payment respectively until everything they previously agreed upon has been done. An escrow company will also ensure the satisfaction of all requirements of both parties, as well as the mortgage company. They protect the buyer by making sure the property is fit for transferral from one owner to the next. Similarly, they protect the seller by ensuring that they will receive payment for the property as promised.

Typically, the selling agent will open escrow with a company of their choice. The escrow company acts as the neutral party handling the financial transfer. They are also responsible for ensuring that all necessary paperwork is complete. An escrow company will also be in charge of reviewing all conditions for the monetary transfer to take place. They handle funds, loan documents and wires, and follow the instructions indicated in the real estate purchase contract.

What Needs to Happen Before Closing a Sale?

But what kind of conditions apply for the transfer of funds to take place? These will vary between each real estate transaction. They may include the finalizing of any previously agreed upon repairs or upgrades to the property. Another typical condition is the successful completion of a home inspection. The buyer passing approval for financing is can be a condition as well. The specifics of each set of conditions will likely be different depending on the transaction. Regardless, the funds and property deed will remain in escrow until the approval of all conditions. In the event that something goes wrong, the escrow officer can ensure termination of the agreement.

Escrow Companies vs. Title Companies

What is an escrow company? The role of an escrow company is separate to that of a title company. A title company handles the transfer from a legal perspective. They ensure that all rights and interests of a property are in line to proceed with the transfer. The role of a title company is to ensure that legally, the property may transfer from one person to another. They must do a thorough check to ensure that there is nothing to prevent this transfer from happening. Any mistakes or misinterpretations in legal documents, false ownership of the property, or previously unknown family members of the seller who may in fact have some form of entitlement to a share could all prohibit a real estate transaction from proceeding.

Individual regions maintain different practices for escrow and title companies, as well as their interaction. For example, in northern California most escrow companies handle both escrow and title tasks. In southern California, escrow and title tasks are separate.

Who Decides Escrow Fees?

Individual states do not regulate escrow fees. These fees will vary depending on the costs of producing the service, any potential liability and possible overhead expenses that may involve a profit factor.  The escrow officer can provide a closing cost estimate at the beginning of the transaction to both the buyer and the seller. This will show the seller how much their approximate net proceeds would be, as well as what they could expect to pay with regards to escrow fees. An escrow company does not have control over the costs of other aspects of the closing process such as title insurance or any changes on behalf of the lender.

Working With an Escrow Agent

The escrow officer’s role is not to provide any kind of advice to either party. They can objectively discuss the instructions for the closing to take place. They must remain completely neutral. The escrow officer cannot advise either buyers or sellers as to whether or not they are making the ‘right’ decision. They also can’t discuss whether either party is or getting a ‘good’ deal from the transaction. Anything to do with legal matters is a discussion that should take place with an attorney, not an escrow agent.

Closing the Sale

The signing of final documents between a buyer and seller will take place at an escrow company. A notary will typically be present. In the instance of an all cash deal, a notary is not a requirement. With all conditions complete, the transfer of the funds and deed between the buyer and seller will proceed. This is typically referred to as the closing date, and takes place several weeks after a formal offer.

Understanding what is an escrow company provides clarity on a critical part of the closing process. Escrow companies ensure that the entire transferal of property and funds from one owner to the next is fair, timely and in line with the conditions of both parties. A neutral middleman, an escrow company will make the final and important stages of buying or selling a home safe and secure for individuals on both sides of the transaction. Learning what is an escrow company early on in the selling process will prepare homeowners for what they can expect when closing.

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