Every home seller will come across the term escrow at some point in their real estate transaction. The word defines the period between signing the sale and purchase agreement and closing the sale.
During escrow, the buyer and his finance company are busy doing everything they need to do before closing. They may feel like there aren’t enough hours in the day to arrange all the inspections and gather the reports and underwriting documents they need to satisfy the contract contingencies. Sellers, on the other hand, are often left twiddling their thumbs during escrow and wondering what all the fuss is about. Yet understanding escrow, and pre-empting the issues that commonly arise, can lead to a faster, smoother sale.
Here’s everything you need to know about this critical stage in your home transaction.
What is escrow?
Escrow is a legal word. It means delivering money and important documents into the care of a neutral third party, called an escrow agent. The escrow agent looks after the things in his care until the happening of a specified event, at which point the escrow agent delivers the documents or money to the party scheduled to receive them.
In the context of a real estate transaction, the buyer does not want to hand over the purchase price until the seller can show clear title. The seller does not want to hand over the deed until she knows that the buyer has paid the purchase price. Without escrow, the buyer and the seller are in a Catch-22 position, with neither of them willing to make the first move.
The escrow agent takes away the stalemate. In a typical real estate transaction:
- The buyer lodges the earnest money, down payment and mortgage financing with the escrow agent, who delivers the money to the seller at closing.
- The seller delivers the seller’s deed to the escrow agent, who delivers it to the buyer at closing.
- The escrow agent gathers inspection reports, such as a home inspection, pest inspection and other surveys, and obtains the buyer’s approval of them.
- The escrow agent monitors the contingencies of the sale and purchase agreement and transfer ownership only when the contingencies are met.
- The escrow agent records the deed with the county recorder’s office.
The escrow agent is always an independent third party. The buyer and the seller appoint him jointly and he must act in accordance with his instructions. He is not an attorney, or a real estate agent. He cannot negotiate revisions to the sale and purchase agreement or give you advice. He’s simply there as a safety net, moving you through the home stretch of your home sale.
Tips for making escrow go without a hitch
When your home sale is “in escrow” it means that the finishing line is in sight — but closing is not guaranteed. The buyer uses escrow to get all his ducks in a row and this leaves room for problems to creep in. While most transactions proceed without a hitch, it’s worth being on the offensive for some of the more common escrow delays.
#1 Buyer financing
Even if a buyer has their financing sorted out before they make an offer, their lender may ask for more paperwork while you’re in escrow to secure the loan. That’s why the majority of financed buyers ask for a financing contingency in the contract, which lets them walk away from escrow without penalty if the loan will not fund.
Tips for sellers: Check that your buyer holds a robust pre-approval from a reputable lender before you accept an offer. Pre-approval means the buyer has already satisfied most of the lender’s requirements, and has established the right level of income, assets and credit history to qualify for the loan. No pre-approval is 100% guaranteed, but in most cases a pre-approved buyer will get his loan.
#2 Lender appraisal
Lenders will not lend more money than the home is worth. The lender’s appraisal, carried out by a certified home appraiser, verifies the market value of the property. This may be different to the sale price. If the appraised value is lower than the purchase price, you have a problem. In this scenario, the buyer may ask that you adjust the price downward (or pay cash at closing for the difference) or let the sale fall through.
Tips for sellers: This is a tricky situation for sellers as you have no control over the value the appraiser gives to the property. If your real estate agent got his comparative market analysis right, you should have listed your property at the right price for the neighborhood. But in some cases, your selling price could legitimately be higher than the property’s fair market value — if there was a bidding war for example, which resulted in a higher than usual price.
The best advice is to keep calm. You do not have to renegotiate the contract down to the appraised value. In many cases, there will be a halfway compromise in the negotiations, whereby you reduce the price slightly, and the buyer makes a larger down payment.
#3 Inspection and repair problems
Home inspections are technically optional, but the overwhelming majority of buyers place a home inspection contingency in the sale contract. A typical contingency gives the buyer 10 days or thereabouts to have the home inspected by a professional home inspector and walk away from the deal if the inspector’s report throws up any nasty, expensive surprises.
Tips for sellers: Expect problems. It sounds blunt, but few homes are perfect and the chances are the home inspector will find something wrong with your home. Luckily, few home repair problems are deal breakers. With a level head and a good agent on your side, you should be able to negotiate an acceptable discount for the major and urgent repairs.
If you want an even safer option, commission a seller’s home inspection before you list your home for sale. A pre-listing inspection will give you a heads up on what the buyer’s inspection is later going to find, so you can either fix any problems at the outset or factor the cost of repairs into the list price. Pre-listing inspections are a great idea for sellers who want a fast close of escrow and are keen to avoid any last minute delays.
When all the contingencies are met and the escrow agent has complied with his instructions, the escrow agent will close escrow. Closings usually occur 30 to 60 days after signing the sale and purchase contract. At this point, the escrow agent will ask you and the buyer to sign any final paperwork, prepare the HUD-1 settlement statement, collect the money, transfer ownership to the buyer and activate the buyer’s title insurance policy. You’ll receive the sales proceeds within two business days.
Congratulations! You have negotiated the tricky process of escrow and have successfully sold your home.