Escrow

I wrote a post a couple weeks back talking about how disappointed I was that our plan to purchase a home had fallen through. Many people reminded me that “everything happens for a reason” and encouraged me that something better would come along. Well, something better did come along, and we are in escrow! I almost don’t want to write about it because I’m holding my breath that this time we will end up as homeowners. There are still some things that might change our plan to buy this home, but now that we have gone through this process for a second time, I do feel more comfortable making these decisions. I’ve learned just how emotional buying a home can be (especially for someone like me who is a first-time buyer).

The first step to complete when purchasing a home is to reach out to a lender to obtain a pre-approval letter. The lender will ask you for information about your income, credit, debts, etc. to ensure you can afford the loan you may be applying for. A pre-approval helps you to make an offer and show the seller you are in good financial standing. At that time, they may give you details on what your payments would look like (including principal, interest, taxes and insurance) based on the price of the home you’re going after. If not, this information will be included in a Loan Estimate (LE) (more details below).

After you find the home you want, you make an offer. This offer letter will be crafted by your real estate agent and details the terms, such as purchase price, close date, and contingencies (i.e. home inspection, loan, appraisal). A contingency means “a provision for an unseen event.” Adding these criteria into an offer gives the home buyer and/or seller assurances based on what is included. For example, the home inspection ensures that the buyer is purchasing a home in a certain condition and there are no hidden issues. Or the seller may add a contingency that they will only sell the home if there are able to find another property to purchase within that same timeframe.

Once the seller accepts the offer it becomes a purchase agreement and you officially “enter escrow.” I never understood the term escrow and what it meant for buying a home until going through this process. Wikipedia defines escrow as “a contractual arrangement in which a third party (the stakeholder or escrow agent) receives and disburses money or property for the primary transacting parties, with the disbursement dependent on conditions agreed to by the transacting parties.” In the case of buying a home, there are two phases where you may have an escrow account: the first is during the purchasing process and the second is post-purchase.

In our scenario, escrow refers the title company managing all of the transactions between us, the seller, and the lender during the buying process; all money and documents will be processed through this third-party during this escrow period. This is to ensure all parties are executing their contractual obligations before any money and/or documents are disbursed to other parties. We are expected to pay the earnest money deposit at the beginning of escrow, which is a small percentage of our down payment. If we were to break our contractual obligations, the seller may be entitled to keep this money. All of the closing costs and our down payment will be paid through escrow before we close on the house.

Now that we have officially entered escrow, we have a 17-day window to complete any inspections (a contingency outlined in our offer). During this window, if we don’t like what we discover, we will have the opportunity to negotiate. We can ask for repairs, money towards our closing costs, and/or a reduction in list price. As with any negotiation, you have to know when you are willing to walk away. If the seller doesn’t agree to lower the price or repair the items requested, will we still want to buy the home? The first time we were in escrow, the answer was “no.” There were too many unknowns uncovered during the inspection. This time around, we have another list of repairs, and we need to determine what can be negotiated and what will be a dealbreaker.

The last thing we are waiting for this week is the appraisal. This is when a third-party company completes an assessment of the property, compares it to other similar properties in the area, and determines its “value.” If the house does not appraise for the amount of our offer, we will also need to determine how to move forward. The bank will only loan 90% of the appraised value, so this can affect our loan terms.

While all of this is happening, we are also reaching out to various lenders to get a loan estimate. This is a critical document that allows people to compare lenders and loan terms. It shows the proposed interest rate, any and all fees, the summary of monthly payments, the total interest charged over the term of the loan, and an APR (a calculation of the interest rate + fees). This creates an easy way to compare terms between different lenders since they’re in the same format and speak the same language. It is important to shop lenders to get visibility into interest rates offered and total costs. These things do differ by lender, and you want to ensure you are working with someone who will give you a fair deal.

Note that interest rates change daily. Early on in the application process the lender may give you the option to “lock” your rate. This means you lock in the loan at that day’s rate, and you typically can’t change it again throughout the escrow process (although my understanding is some lenders may allow you to do so for a fee if it makes sense). If you choose not to lock in, you are choosing to “float” the rate and lock it in at a later point during escrow. The decision depends on whether you think rates will increase or decrease during escrow; either way you are taking a gamble. In my case, I noticed rates were steadily increasing so we locked in ours early on in discussions with the lender.

As mentioned above, the second type of escrow is post-close. Some lenders maintain an escrow account called an escrow account for taxes and insurance, or an impound account. This account is typically mandatory for buyers who put less than 20% down. This account is to collect monthly property taxes and insurance amounts, in addition to the mortgage (principal and interest) payments. This gives the lender more certainty that these large payments (usually paid annually or bi-annually) will be paid, protecting their investment. This goal is to avoid any potential lien on the property, i.e. the IRS can put a tax lien on your property if you do not pay your property taxes. The lender I am working with gave me the option to forgo an impound account, which I am taking him up on. This way I can instead keep the taxes and insurance money in my high-yield savings account (HYSA) to earn interest throughout the year.

We are anxiously waiting for some of these things to fall into place before we feel 100% confident that we will move fully forward with the purchase. I will keep you all updated, and I’m sure there will be a post coming soon to celebrate once we do make it to our close date (either on this house or another!).