What Is Escrow? Everything to Know

Every year, you hear real estate agents clamoring that now is the best time to buy. Even if the housing market itself is in great shape, the process of buying a house can prove difficult to navigate. This holds especially true if you don’t have a background in real estate, law, or finance.

Among the many confusing terms you’ll encounter during your house-buying process, “escrow” can be one of the most difficult to parse. What is escrow, and how is it used when you go to buy a house? Our helpful guide will tell you what you need to know.

What Is Escrow?

Let’s start by answering the big question: What is escrow? Escrow is, in simplest terms, an asset that a third party holds until all terms of a contract are met. It acts as a sort of insurance that both buyer and seller of a home, business, or other asset meet their obligations.

The buyer chooses the third party that holds the escrow funds. However, the seller must also agree to the choice of escrow holder.

Is an Escrow Account Only Useful for Homes?

While you’ll most often see an escrow account or escrow balance referred to in real estate, it’s not only useful for homes. Placing funds in escrow helps the buyer and seller insure contract compliance in business sales or any contract where both buyer and seller must furnish large amounts of money.

However, in many cases, an escrow account will continue to serve the buyer long after the home sale closes. Real estate lenders will often allow escrow accounts to cover property tax and insurance costs.

Do I Have to Place Funds in Escrow?

With all this in mind, you may wonder if you have to place funds in escrow when conducting a real estate transaction. The simple answer? No, you don’t. There is no law requiring you to place your funds in escrow.

However, it would be a wise idea to do so, as an escrow fund rests in a third party’s hands, rather than going directly from buyer to seller. This can prevent disagreements or messy legal battles over where funds should be allocated.

Yet, this does not preclude the possibility of arguments over funds and contractual obligations. In such cases, you may need to call upon an interpleader action to help resolve such disputes.

What Do Escrow Accounts Not Cover?

While escrow accounts can cover mortgage payments, insurance, and property taxes, they cannot cover every expense related to your home. Escrow accounts don’t cover utility bills, home owner’s association fees, or supplemental tax fees.

Let’s Review What You Need to Know About Using Escrow

What is escrow? Let’s review what we’ve learned. An escrow account is a third-party asset held to ensure all contractual obligations between buyer and seller get met. These accounts most often appear in real estate but can apply to any transaction. In real estate, an escrow account can cover property taxes and insurance costs.

Still confused? Don’t worry, we have plenty of other articles that can help explain complex financial concepts on our blog. Check us out for more information.