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You’ll no doubt hear the word “escrow” many times during your home buying transaction. It can get a little confusing, especially for first-time buyers, as the word is used to describe different things. In general, it means that your money is being held by an impartial third-party until the deal is completed. This provides a safeguard against any foul play by either side.

What is escrow and why do I need it?

At its simplest, escrow is a deposit of funds that are held by a third party and released upon the completion of a particular condition or event. Whether you’re a buyer, seller, lender or borrower, you’ll want the assurance that no funds or property will change hands until all of the conditions in a transaction are complete.

The escrow holder has the obligation to safeguard those funds and disburse them once all the provisions of the escrow are met. As closing day arrives there are a few different ways that escrow comes into play. Below are the four most common.

The deposit

One of the requirements, when you sign a purchase contract, is that you put down a certain amount of your down payment in escrow. This is usually 10% and is made to show that this is a serious offer and to show good faith. This is held until closing when you’ll then owe whatever amount of the down payment is remaining. Think of it as a portion of your down payment that you’re parting with earlier than the rest.

This is usually very straightforward unless you’re buying with a non-contingent contract. In this case, you’ve agreed to a deal outright that is not contingent on certain conditions like approval for a mortgage. If the deal falls through on a non-contingency contract you could stand to lose your escrow payment.

Maintenance charges in a co-op

If you’re buying a co-op your probably aware that you’ll need a certain amount of post-closing liquidity upfront. This puts the co-op board at ease as it shows you have enough cash in the bank to cover mortgage and maintenance payments up to a certain time, for instance, one year’s worth. But some co-op boards go a step further and ask that you put some months’ worth of maintenance charges in escrow.

This is often done as a financial safeguard if the board feels a bit uncertain about a buyer’s finances. For example, a buyer who is a contract or freelance worker without regular paychecks. How many months’ worth they ask of you depends on each individual case.

When repairs are needed

In this case, it’s the seller that must put the money down. You’ll normally see this happen when a problem is found either during the walk-through or home inspection. For instance, a pest problem is found, or an appliance doesn’t work. If the buyer feels uncomfortable about this, they can ask for an escrow payment. That way, the buyer has an insurance policy. If the seller makes the repairs the escrow deposit is released back to them. If they fail to do so, then the buyer gets the deposit which can be used towards fixing the problem.

With your mortgage lender

It’s quite common for mortgage lenders, before granting a loan, to ask that you pay several months of taxes and insurance costs. This serves as a security in case, for whatever reason you can’t make your mortgage payments. This could be anything from 2 to six months or sometimes more which will be held in escrow.

Buyers are rarely happy about this so it’s good to know that this can usually be negotiated. Depending on your bank, you may be able to get this waivered. If you can then there will sometimes be a small fee. Unsurprisingly, in order to get this deposit waivered, you’ll need good credit.

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