What is an escrow account, how can I open one and when/why I should create an escrow account.

by | Indy Anna, Real Estate Investing, Uncategorized

What is an escrow account, how can I open one and when/why I should create an escrow account.

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Here’s what we are about cover today regarding escrow accounts…

– 11 things real estate investors need to know about escrow accounts.

– The 7 steps to setting up your own escrow account by yourself.

– When and why to use escrow services and a few banks and other places that can help.

Escrow accounts explained:

The 11 parts to understanding escrow accounts AND the seven steps to set up your own escrow account…

Here’s the question:

“How exactly does an escrow account work?”

I’m going to cover escrow accounts for you today and make it super simple to understand!

Forethought:

There are basically four types of escrow accounts.

Homebuying:  This is for the purpose of earnest money and protecting it for the buyer and seller to see “proof of funds”.

Monthly Payments:  This escrow account is to break down larger payments into smaller ones that can be paid into each month.

Those Used by Renters and Landlords:  This escrow account is to settle disputes or hold things like  security deposits.

Buying Goods and Services:  This escrow accounts can be used to escrow for overseas transactions, like Amazon.

For the purpose of this lesson, the intent is to explain escrow as it would be used in the process of buying a home.

The 11 Parts to Understanding Escrow Accounts…

First we’ll go over the 11 parts.

Then we’ll go over the seven steps to set up your own escrow account.

During this time I’ll also explain when/how/why you would need an escrow account for different scenarios and situations as a real estate investor and/or a regular homeowner.

Part 1:  Money from one party to another.

An escrow account is a way for one party, to pay a different party, by means of a third party.

For example: If Jim needs to pay his insurance company for homeowner’s insurance, he can pay it through an escrow account.

Why would Jim want to do this?

Well, let’s say Jim’s annual premium is $1,200.00 each year due each June 1st.  One way to do this is that he can pay into escrow $100.00 a month and have the escrow company pay the insurance company on
Jim’s behalf.

That saves Jim from paying out $1,200.00 in a lump sum each June 1st.

Here’s another why…

Let’s say that Jim was putting an offer down on a house.  By having money in escrow account, the seller’s know that Jim is a serious buyer.

Part 2:  Escrows are a Contractual Agreement.

This is a contractual agreement.  So Jim, and/or the other parties he’s paying money to through the escrow agent/company, aren’t allowed to touch these funds.  Meaning Jim, nor a company like ABC Insurance, won’t be able to withdraw the money.

The paying out of the money will be up to the escrow company/bank/title company/etc.

Why are escrow accounts set up like this?

This is because each person being paid from the escrow account is considered an ‘obligation’, or a must-pay in other words.  These are parties that have entered into agreements with Jim and Jim’s agreement to pay them.  Once the escrow account is set up, Jim and the escrow company are bound to pay.

Part 3:  You don’t need to do this with a bank.

Often escrow accounts will be set up with a bank account and through a bank but it is not necessary to go through a bank.  Banks are not the only ones to hold the right to have escrow accounts.  Escrow accounts can be set up online (though not for physical property sales by law), brokerage firms, title companies, as well as banks.

Why the options?

The escrow company is only a neutral third party that will pay out the funds, and otherwise has no  interest in the money itself.  So if the realty company you’re working with offers escrow accounts, for example, it means they are simply holding funds and will pay them out for you when it’s time.

Part 4:  Not just anybody can always act as an escrow agent.  (Usually)

You want to check with your realtor and attorneys and make sure that you set up your escrow accounts by the book.  A random person can act as escrow in some cases, Jim’s brother for example could not be the holder of his funds unless of course Jim’s brother was an escrow agent.

Why do you need an escrow agent?

Because escrow accounts are legally binding contractual agreements between various parties so the  escrow agent must be qualified to disburse funds and follow the the other terms of the contract. 

There are different types of escrow accounts where the escrow agent is not held as the legal trustee for the account, but this still doesn’t mean that a random person can act as an escrow agent.

Part 5:  An escrow account may or may not be required the lender.

The situation will depend on what your bank or the lending institution requires so you want to check with them first.  It may or may not be required for you to have an escrow account per your lender.  It is not always a must and sometimes you are given the choice to have one by your lender.

Why the choice on escrow?

It depends on your lender, and their policies regarding escrow accounts.  In some cases it’s not necessary to have escrow accounts.

For example, if your loan amount is less than 80% of the value of the property then you may not be required to have an escrow account.

This may cause your interest rate to go up if you choose not have an escrow account as it makes you more of a liability in some lender’s eyes.  They may prefer to see an escrow account used to pay for required things like insurance, so check with them.

Part 6:  You can set up an escrow to pay for just about anything.

Pretty much anyone can set up an escrow account for anything.  Let’s say Jim wasn’t required to have an escrow account by his lender, but he still wasn’t keen on paying a lump sum out for things like homeowner’s insurance, property taxes, HOA dues, etc.

What could Jim do and why?

Jim could set up an escrow account online by himself.

You can set up an escrow account to pay for basically everything except the purchase of physical property.  Jim could set up an escrow account by himself online and not need any further approval or wait times.  Jim could also ask his lender to set one up, or his bank, the title company he’s working with or the brokerage firm he’s working with as well.

Part 7:  Escrow account pricing is negotiable and can even be free.

Escrow accounts can be pretty cheap to set up or even free.  In some cases the price can be negotiated or reduced as well.

Why so much latitude?

Banks and lender’s don’t really make money on escrow accounts, as they make the bulk of their profits on interest charged on loans/credit.  For banks, lenders, title companies, and brokerage firms acting as
escrow, there is usually a flat set up fee + $1-$2 dollars for thousand of the purchase price (on something like a home) and in the same range for other kinds of payments.

For example, if Jim bought a house for $100K…

The flat rate to set up escrow with his lender could be $100 – $200.  In some cases this can be negotiated or even done for free.  Remember that your bank, or HOA or whoever is getting your money, should be happy that you are setting up an escrow account to pay them without thinking.

We often have any landlords offer to pay for this to set up auto-payments for their tenants.  This is often safer than just trusting that a contract buyer for example will keep up the payments for things like taxes, HOA, etc.

Part 8:  Often buyers and sellers will split the escrow costs 50/50.

While most things in terms of a home purchase are negotiable, it is typical for the seller/buyer to split the escrow fee costs 50/50.  In cases like this they can include these costs as part of the closing costs.

How can escrow be done like this?

If Jim is buying the house from Nancy, and the escrow fee is $300.00 then Nancy would most likely pay half of that amount at $150.00.  This could be paid in full by Nancy but likely it would be made up for somewhere else so that is paid in half.  Splitting 50/50 is most common.

Part 9:  You can set up an escrow accounts for anything you don’t want to pay in a lump sum.

If you are required to set up an escrow account, decide what’s most important to you.  If you’re not required to set up an escrow account then you can decide if you’re able to pay for things in one lump sum as they come due.

Why do you have this choice with escrow accounts?

You may have to set up an escrow account as a requirement but you may have a choice over what that account is used to pay.  So it can depend on what is most important to you personally even if you’re required to have an escrow account.  If your lender can set one up without any hassle and is requiring you to have one, maybe their fees are worth it to you.

Don’t be scared to shop around.

Be open to shopping around if you are comfortable finding cheaper fees for an escrow account and getting it set up apart from your lender.  Consider your other escrow options if your lender allows it.

If you go raw without an escrow account just be sure that you are aware of how much certain things cost each year.  You want to make sure and budget for them if you’re not required to have an escrow account and you are paying in lump sums.

Part 10:  You can be anti-escrow account, but make sure you know what category you fall into.

If you are anti-escrow be SMART!  You might fall into two different categories here…

Why do I say that?

Well, you’re either independently wealthy and paying for things in lump sums will not be an issue for you (congrats!) OR you’re not required to have one for per your lender and don’t want another party involved in paying things out for you.

If you fall into the latter category then it may cost a little bit more but you can still have things broken down in some cases and avoid a large lump sum.  You want to try to get a deal so that any time you agree to pay in large sums you should always get a discount or a bonus of some kind.

I want control!

If you are just a control freak that wants to be in control of your payments you can still workout some kind of breakdown.

For example…

$1,200.00 each year for home owner’s insurance might be broken down by your insurance company into quarterly payments of $500.00 each.

Part 11:  You can set these up for (private) seller financing deals.

In cases of private sales in real estate, there could still be the need to set up an escrow account.  Meaning even if you aren’t using a lender or a real estate agent in this transaction, there may still be funds that would be safer if disbursed through a third party.

Why set up an escrow account this way?

In cases of private sales, it allows for a certain amount of protection for both the seller and the buyer.  It proves to the seller you have the funds (earnest money) and it keeps the buyer safe as conditions of the contract will be met before the escrow is paid out.  It can also be used with tenants to make sure they pay for things like insurance, HOA dues, etc.

For example, let’s say that Jim is buying Nancy’s home as a FSBO listing.  Jim is not a realtor.  The home inspection reveals the roof needs repaired and Nancy agrees to repair it.  Both parties would be pleased using an escrow account.

How would the escrow account help?

Jim would know that Nancy would fix the roof before she got ahold of his money.  Nancy would know she was going to get paid for her home (because she knows Jim has the money to complete the
transaction in escrow) after the agreed upon repair is made.

Seven steps to set up an escrow account on your own.

So we just went over one situation where you would want to set up your own escrow account.

There may be other reasons too but those are just a few examples.

So in that case here are the simple seven steps to set up your own escrow account.

Step One:  Document the need and goal for the account.

First you need to know the reason WHY you are setting up the account.  In this case Jim would have a copy inspection report stating the roof needing repairs and written in a contractual agreement (along
with the other purchase terms) Nancy’s agreement to fix it.

Step Two:  Find an escrow agent.

I explained earlier that you can use banks, lenders, title companies, attorneys, etc.  Remember that for a physical property you may not be allowed to use online only services for escrow, so get that answer and be sure before you move forward.

Step Three:  Get and submit ALL paperwork regarding the sale.

You need to collect all of the relevant information about the sale.  This includes the purchase agreement, inspection report, seller information, buyer information, financing information (including seller financing deals), payment information (including if buying on terms),any personal property involved (ex: the appliances staying), and any further inspections that will or have been done such as termite, radon, etc. (and who did or will do them)…

This may seem like overkill but if there is a problem remember that the funds from escrow may not be released back to you or anybody else until both parties agree.  The more clear documentation you have about each party’s role the better you will eliminate problems later.

Step Four:  Have the exact amounts ready when you visit your escrow agent/company.

I have had more than one situation where they did NOT bring the money lol.  Be ready and have the money ready to go on your visit.  You may also have to provide ACH credentials or other bank account info so that you can do direct deposits or receive them.

Step Five:  Meet with the escrow agent/company and confirm all the details with the Escrow Confirmation Agreement.

You want to have the “Escrow Confirmation Agreement” which is basically a ONE page document that explains all of the relevant background information about the transaction, money, payments, etc.  Make sure the other party or parties get this and everybody signs off.

Step Six:  Communicate with the other party to confirm details.

If you are splitting the cost then make sure this is done immediately or at least arranged immediately.  Also they should sign off on the “Escrow Confirmation Agreement” as well so there are no surprises.

Step Seven:  Make sure to get ALL the escrow documents and numbers, store them and share them with the seller and other relevant parties.

You want them to know that you take this seriously.  So after the “closing” and even after the confirmation document you STILL want to make sure that they get all the relevant correspondence from the escrow group.  The more we eliminated surprises, then more we eliminate problems.

So those are the seven steps in setting up your own escrow account.

All that being said, it might be easier and more cost effective to use an escrow account that is set up for you with a lender or something.

I also made a video before this about setting up your own escrow account and I’ll put that below as well.

Escrow is far more used in everyday business than you might imagine sites like AliBaba, Amazon, etc. are types of escrow accounts that most people use daily.  For investors though, when it’s time to set up your own escrow account, and the reason behind them, it’s easy to do when you know the process.

Escrow is simply a third party (neutral) that is holding funds on the behalf of other parties.

In cases of real estate transactions, it provides the seller with proof of the buyer’s funds and intent to buy.  It gives the buyer the means to tell the seller they are serious while they are completing their due diligence, before closing.

If you’re using an agent, odds are they will have an escrow company in mind to use, or the brokerage firm itself will be the ‘escrow agent’.  If you’re using an agent, most often the agent will be setting up the
escrow account for you.

The set up of the escrow account is the same either way…

Any way it’s set up, it will work the same- the third party (the escrow company) will be holding and distributing the funds when the terms of the escrow are met (such as at closing).

When setting up your own escrow account the steps are pretty easy…

The first step, if you’re not using an agent, is asking your bank if they will set up an escrow account for you.  You can also ask your title company or look up local escrow companies online.  The second step is to get all of your information together including the addresses, buyer/seller names, financing info and terms, inspections, responsibilities of each party, payment info, etc.

I covered these steps above as well in “how to create your own escrow account”.

Lastly you just need to make sure everybody does their part between you, the other party and the escrow service.

Even if you’re not required to have one, you can still get a bank or lender to set up your escrow account.  It will end up being a personal decision.  If you decide to have an escrow account, I want you to know
where to be able to go so here are a few places so you can check out First American, First Interstate Bank and PNC escrow services.

Okay so that was all about escrow accounts…

– 11 things real estate investors need to know about escrow accounts.

– The 7 steps to setting up your own escrow account by yourself.

– When and why to use escrow services and a few banks and other places that can help.

Thanks so much!  = )

Make the Universe Smile.

~ Indy Anna
Love (at) BigReia.com
(317)969-5619 (that’s my cell phone and yes I actually answer lol)

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