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Understanding The Mortgage Escrow Process

Understanding The Mortgage Escrow Process
Written by Publishing Team

If you’re preparing to buy a home, you’ve likely heard the word “guarantee” at some point. Here’s what to expect in the warranty process.

What is a warranty and how does it work?

Escrow is a technically legal process in which a third party holds money in a specific account for a specified period of time until a certain condition is met, such as fulfilling a purchase agreement.

There are three common types of escrow accounts. The first is used to buy a house.

“The purchase agreement usually includes a requirement for the buyer to make a serious financial deposit,” explains Tom Trott, branch manager of Embrace Home Loans in Frederick, Maryland.

A deposit of earnest money — generally 1 percent to 2 percent of a home’s price — is held in an escrow account until the contract is finalized, after which the money will go toward the buyer’s down payment or closing costs. If the agreement is canceled, the deposit will go to the buyer or seller, as stipulated in the contract.

The second type of escrow account is managed by a mortgage lender or service provider, and the money you deposit is used to pay property taxes, homeowners’ insurance, and mortgage insurance (if applicable).

The third type of guarantee, if needed, includes anything not resolved in the property contract.

For example, if the seller leaves furniture, does not complete repairs, or if property is damaged, the settlement company may hold the seller’s money in escrow until the contract is fulfilled. “Once fulfilled, the money will go back to the seller or used to pay outstanding bills.”

Is warranty required?

When buying a home, putting money into an escrow account is required under certain conditions.

“Traditional loan guidelines recommend escrow accounts for first-time homebuyers and borrowers with poor credit, but they don’t mandate these accounts unless they score below 20 percent,” says Chad Holsted, mortgage loan originator at Silverton Mortgage in Atlanta.

Holsted adds that escrow accounts are also required for FHA loans.

For VA loans, you must pay at least 10 percent to opt out of the escrow account.

Warranty process steps

After arranging a mortgage and when you make an offer to buy a home, the guarantee process includes several stages:

1. Opening an escrow account

The first step is to open an escrow account, which is usually done by the seller, but can also be done by the buyer.

Lyle Solomon, lead attorney for the Oak View legal team in Rocklin, California, explains. “Your agent will begin this process once you and the seller have agreed on a price and signed a mutually acceptable purchase agreement.”

An escrow agent could be a real estate firm, a bank or other financial firm, or it could be a private third party tasked with this task. Alternatively, this process can be managed by an attorney, in which case it may be referred to as a “settlement” rather than a “guarantee.”

2. Home appraisal and inspection

Your mortgage lender will ask for a home appraisal. If the appraised value of the home is less than the suggested purchase price, the lender won’t give you money for your mortgage unless you’re willing to pay the difference in cash or the seller agrees to bring the price down to appraised value.

As a buyer, you have the option (and should) hire a home inspector to carefully assess the condition and habitability of the home.

“Your home inspector will look closely at the structural integrity, electrical and plumbing, kitchen, bathrooms, windows, roofing and heating system and provide you with a report, which will detail any outstanding conditions that need addressing and any repairs or upgrades,” explains James Orlando, vice president of Brooklyn MLS in New York.

You will also need to review the seller’s disclosures. The seller is obligated to report known negative conditions or defects that currently exist in the house.

“You should receive a written Seller Disclosure Statement that points out any obvious errors and review it carefully with your agent,” Solomon says.

3. Get insurance coverage

The mortgage lender will require you to obtain home equity insurance, and pay title insurance. Unless you take out an additional landlord’s policy, title insurance primarily protects the lender from any legal challenges that may arise from defects in home title or ownership.

4. Final Walkthrough

Assuming everything goes well with the appraisal and inspection — and nothing has changed in your financial situation that could impede your approval of the mortgage — you’ll have the opportunity to visit the home just before closing for one last round. This helps ensure that there is no new damage to the home and that the seller has met the terms of the purchase contract, such as leaving appliances or fixtures they agreed to.

“You generally won’t be allowed to retreat at this point unless the house has been severely damaged,” says Solomon.

5. Conclusion

Orlando says that at least three business days before the deal closes, you’ll receive a final disclosure document from your lender with a final list of closing costs, including collateral amounts. Compare this to your loan estimate (which you received when you applied for the loan) to ensure that there are no material changes in costs.

“There is a lot in common between these two documents,” Solomon says. “Look for any unnecessary, unexpected, or excessive expenses as well as any errors.”

When it’s time to close, the escrow agent will create a document that you name the homeowner and file it with the local records office, then transfer the money to your escrow account so the seller and the seller’s lender can be paid, Solomon says. You will need a bank check for the remaining down payment and closing costs.

6. Pay the insurance and taxes

After you buy your home, a different type of escrow account is managed by your mortgage lender or service provider, with the money in that account transferred to property taxes, homeowners’ insurance, and (if you’re required to have it) mortgage insurance.

The lender will divide these annual amounts by 12 and add them to the monthly mortgage payment. When these bills are due, they will be paid on your behalf automatically from your escrow account balance.

“You will receive an annual escrow statement once a year that details payments in and out of your escrow account,” Holstead adds. You will also be notified of any owing shortfalls or refunds owed within 30 days of preparing your statement.

You may be able to terminate your mortgage escrow account eventually, although the restrictions on doing so vary from lender to lender. If this is an option, you’ll need to be in good standing with your payments, says Solomon.

However, keeping an escrow account can give peace of mind — it ensures your bills are paid on time, and you won’t have to keep track of them, says Holstead.

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