What is Escrow?

If you’ve ever purchased a house, you’ve likely encountered the term “escrow” or the phrase “in escrow.” While it’s most often associated with real estate, escrow is also used for other large purchases to ensure you’re getting what you paid for – or that you’ll receive your payment when selling something. Here’s a look at what escrow is and how it works in your favor during both buying and selling.

The Basics

According to experts at Zillow, “Escrow is when an impartial third party holds on to something of value during a transaction.” In today’s world where things like photos can be edited and flaws can be hidden, escrow protects both buyers and sellers. Instead of giving down payment money directly to the seller, the escrow holder (usually a company or lending institution) keeps it until both sides are satisfied with the transaction, preventing the seller from running off with the money or pulling the item off the market.

Buying a Home

When you make an offer to buy a home and the seller accepts, you typically write an earnest money check. As Cathie Ericson of Realtor.com explains, this check usually represents 1-3% of the agreed-upon sale price and shows you’re serious about the purchase. Instead of the seller cashing it right away, the escrow entity does so, proving the check is valid and notifying the seller.

Escrow acts as a neutral party, ensuring both sides meet all conditions before the deal is closed. This includes arranging home inspections and securing financing. Once all the requirements are met, you close on the home and the funds in escrow are applied toward the purchase price.

If you exit the deal improperly, the seller can keep the earnest money for their time, as noted by Zillow. On the flip side, if the seller breaches the agreement, you get your money back.

After the Purchase

Once you sign the papers and receive the keys, the house may feel like it’s all yours. However, if you have a mortgage, the lender technically owns the house until the loan is paid off. They may use an escrow account to cover property taxes and homeowner’s insurance.

As Brian O'Connell of TheStreet points out, if you fail to pay these, it can expose the lender to risks, including loss of value and penalties. To protect itself, the mortgage servicer may make these payments on your behalf using an escrow account, funded through your monthly mortgage payments.

Why Escrow Matters