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November 16, 2018

What's an Escrow?

Some real estate agents toss around the word “escrow” not realizing that to many sellers and buyers the concept of a deal being in escrow is a mystery. Just what is this strange place called escrow and what happens there?

Your First Escrow

I recall a broker telling me about a rookie agent who put together a sale in her first week, something almost unheard of. The broker heartedly congratulated the new agent and told her to put the signed contract into escrow. A few days later the broker asked the agent how it was going. Fine came to the response, “It’s in escrow.”

A week later the broker called the escrow company who acted surprised. They hadn’t seen any paperwork on that deal. The broker called the agent and asked again where was the contract, to which the agent responded that she put it in escrow. The broker said show me. The agent went over to the filing cabinet and opened the drawer marked “escrow” – In the section marked “In Escrow” lo and behold there was the signed contract between buyer and seller.

So, just to be clear about what is this mysterious place called escrow, here’s a discussion from my book The Language of Real Estate, Dearborn Publishing:

Escrow Explained

The process by which money and/or documents are held by a disinterested third person (a stakeholder) until satisfaction of the terms and conditions of the escrow instructions (as prepared by the parties to the escrow) has been achieved. Once these terms have been satisfied, delivery and transfer of the escrowed funds and documents take place. Although in some states a real estate broker is authorized to handle escrow functions, the common practice is to employ the services of a licensed escrow company, title company or lending institution. In some states, it is called a settlement service.

Escrow can be used to close the following types of real estate transactions: sales, mortgages and exchanges; sales using a contract for deed; and leases of real estate. In all cases, the escrow holder acts as a fiduciary and retains documents and entrusted assets until specified conditions are fulfilled. The holder is the special and impartial agent for both parties and acts in accordance with the escrow instructions given by both. The sales contract usually serves as the basis for escrow instructions for both seller and buyer because it contains (or should contain) the agreement of the parties concerning who must pay the various expenses, the proration date and the like. This importance of the sales contract underscores the critical role of the real estate salesperson or broker whose responsibility is to advise the parties and properly complete the sales contract form (and advise the parties to seek legal counsel if appropriate).

If the contract has been unprofessionally prepared, the escrow company may be delayed or even prevented from closing the transaction. It is important to remember that an escrow agent does not prepare or review the legal documents—escrow merely takes directions from the parties to the contract and acts on them in a confidential manner. Thus the parties should not rely on the escrow agent to discover defects in the transaction. If an established escrow company is not involved in the transaction, an attorney should be consulted about the preparation of proper escrow instructions.

Escrow is a Limited Agent

Because of the escrow’s limited duties of disclosure and the confidentiality of the escrow in general, facts known to the escrow holder are normally not imputed or implied by the other party. Escrow is a limited agent for both parties, but once the conditions to the escrow transaction have been performed, the nature of the dual agency changes—escrow then becomes the agent for the seller for the money and the buyer for the deed. Escrow acts as the “clearinghouse” for the details of the transaction. Escrow cannot be unilaterally revoked, and in the event of disagreement the escrow can only be amended, changed or revoked by mutual agreement.

In closing a real estate transaction, the escrow company may perform such duties as paying liens, computing prorations, ordering title evidence, having new documents prepared, drawing up closing statements, obtaining necessary signatures, recording documents and receiving and disbursing funds. After payment of their respective closing costs, the buyer is thus assured of receiving a clear title, and the seller is assured of receiving the appropriate funds. Typically, escrow fees are split equally between buyer and seller.

Some special situations to which an escrow arrangement is most appropriate are closing on sale and immediate resale or purchase; closing when several lenders are involved either in new mortgages or releases of prior encumbrances; closing an entire condominium project when purchasers’ funds must be escrowed under state law; closing a VA or an FHA loan (an FHA and VA requirement).

Once a valid escrow has been set up, and a binding and enforceable contract of sale has been deposited with the escrow holder along with a fully executed deed, the death or incapacity of one of the parties to the escrow will not terminate the escrow. Upon performance of the decedent’s part of the contract, the other party is entitled to have escrow concluded according to the terms of the contract.

Meeting Major Contingencies

An escrow is usually not opened until major contingencies in the contract of sale have been met. Such major contingencies might be the arrangement of new financing or the approval of a loan assumption, building permit, zoning change or the like. Among the contingencies that can be taken care of after the start of escrow is the appliance check, the termite inspection and the signing of bylaws or house rules.

A related term – “holding escrow” is an arrangement whereby an escrow agent holds the final title documents to a contract for deed. Holding escrows are often suggested as the solution for the problems that arise under a contract for deed when the buyer is ready to pay off the balance owing on the contract but the seller either cannot be found or is not cooperative about executing the deed. Under a holding escrow, the seller, at the time the contract for deed is signed, deposits with the escrow agent an executed deed or assignment of lease and instructs the escrow agent to deliver the conveyance to the buyer when full payment is made under the contract. Many escrow companies are reluctant to handle holding escrows, even when they are indemnified against loss, because of the following possible complications:

It may be difficult for the holding escrow to ascertain whether there has been a full payoff, whether the amount deposited in escrow is the correct amount and whether the buyer is in default under any other terms of the contract for deed.

Difficulties may arise if the seller dies, particularly regarding determining the rights of his or her heirs. Other problems may arise if the seller remarries, and new dower, curtesy or marital rights must be considered.

If the buyer has resold the property still under contract and used a different escrow agent, the seller will be requested to draft new documents conveying title directly to the new buyer. Thus, there sometimes are added costs.

While the holding escrow practice is good in theory, these practical problems may prevent its effective use. A good alternative is to establish a collection account with the lending institution where the seller has an existing mortgage. The collecting agent will know how to contact the seller if the buyer wants to quickly pay off the outstanding balance and receive a deed to the property. Also, the buyer can thus be assured that the seller’s mortgage payments are being made as long as the buyer makes his contract for deed payments—and vice versa—the seller can be notified if the buyer is in default in making payments. This situation is sometimes called a true escrow.

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