What is Escrow?

Escrow is a legal arrangement to have a licensed neutral third party hold funds or property until particular contractual conditions or obligations have been met. During a property transaction, it protects both the buyer and seller from being defrauded by the other party.

An Escrow Account holds the seller’s funds for property taxes and homeowners insurance; it also holds the buyer’s Earnest Money—converting it to their down payment or closing costs once the sale is complete.

During a financed purchase, the escrow account holds funds for taxes and homeowner’s insurance throughout the mortgage term. After the purchase, the lender will establish an escrow account for the buyer’s taxes and insurance and deposit funds from the monthly mortgage payment until taxes and insurance payments are due.

If the buyer is building a new home, the funds will remain in escrow until the construction and purchase are finalized.

Why does Escrow matter?

Escrow is important because it protects the buyer, seller, and lender (if applicable) in the exchange of property and funds. The Escrow Agent also guides most of the closing process.

An escrow account protects the buyer’s Earnest Money if they need to cancel the deal and invoke a contingency after signing the Purchase and Sale Agreement (PSA).

Escrow also protects the seller: having the Earnest Money held in the escrow account keeps the buyer accountable for their responsibilities in the closing process. Additionally, the seller deposits prorated property tax and insurances into the escrow account. These funds are then managed by the escrow account—ensuring the funds are secure and bills are paid timely.

Is an Escrow Agent or Escrow Account necessary?

It’s possible not to have an escrow account. However, there are risks—such as missed payments, failure to exchange funds, or fraud by either party. 

Escrow accounts are also required unless borrowers meet certain conditions, such as a 10% or 20% minimum down payment for VA loans and conventional loans, respectively. FHA loans require an escrow account in all cases.