The Escrow Process and Earnest Money

What is the Escrow Process?

 
Before you can understand the escrow process (which is really very simple) you need to know what escrow even is. Escrow is an account (sort of like a bank account) that you set up with your lender, an escrow company, or title company when purchasing a new home. An escrow account is used to hold your earnest money while you are waiting for a property deal to close. The escrow company serves as a neutral third party that will control how and when this money is delivered to the appropriate party. This serves as a form of insurance for both the seller and the buyer.

Escrow companies are used because they ensure that you have the required funds for the home purchase available in an account that is monitored by someone other than you (which would not be the case with a personal bank account). In essence this is a form of insurance against the possibility that you will come up short on funds at the last moment. Escrow accounts also ensure that the seller or lender on the property does not have access to your funds unless the deal goes through completely and you are granted the full title. Basically, it serves as insurance for you that your earnest money cannot be used at any point before you have full ownership of the property.

The escrow process includes contacting an appropriate escrow company and submitting your funds and documentation. The seller you are dealing with will not be able to access the funds until you are satisfied with the home buying arrangement. They will, however, be able to see that the money was deposited. This allows them to see that you are a serious bidder.

 

What is Earnest Money?

 
Earnest money can be thought of as a security deposit on a home purchase. It is a good faith deposit that you are making in order to confirm to the seller that you have a real and legitimate interest in the home. It is generally held in escrow while you are negotiating the home purchase, and is not to be confused with a down payment; though it is often put toward the down payment when a deal is reached and approved.

There is generally no set amount for an earnest money deposit, and it may vary by lender, location, and home loan value or property market price. There are some things you will want to keep in mind when it comes to making sure you do not lose your earnest money deposit (which can happen if you aren’t careful!).

  • Never give your earnest money directly to the seller.
  • Make sure your offer letter for the home includes a contingency saying that your
    earnest money will be returned to you should the sale not be approved.
  • Use a reputable third party or escrow company.
  • Do not authorize any release of your funds until the deal has completely been
    closed.
  • Keep your receipts.

 
As a final note, you may want to include a caveat or contingency in your offer letter that states what the earnest money will be used for (down payment, closing costs, etc.) if the deal should go through.