How Do Escrow Accounts Work in NYC Real Estate?
An escrow account, simply put, is a holding account.
It’s a procedure where a neutral, third-party entity—typically an attorney or title company representative—(temporarily) holds a buyer’s deposit and important documents related to a home sale.
Placing funds and important paperwork in escrow acts as a safeguard, to maintain integrity in the homebuying process.
The funds and documents are only released from escrow after closing--after both the buyer and seller have satisfactorily completed all mutually agreed upon aspects of the sale.
How Escrow Accounts Work
- Escrow accounts "hold" monies until a transaction can be completed.
- Escrow accounts exist to protect all parties in the case of a real estate deal, so money does not get exchanged before a contract is executed.
- In a real estate purchase, the earnest money deposit is usually placed in escrow once the sales contract is signed.
- Mortgage companies use escrow accounts to put your property tax payments and homeowner's insurance to ensure that your property taxes get paid annually.
- In rentals, deposits in escrow may be returned to the applicant or transferred directly to the landlord.
Why Do Escrow Accounts Exist?
Protection is the primary reason for having an escrow account: It enables all stakeholders in the buying process to move forward with a greater sense of trust—and peace of mind.
As mentioned, the deposit and important documents like the title deed won’t be transferred until all of the established escrow terms have been checked off.
To make the escrow process even more amicable, both the seller and buyer should mutually agree on who the escrow agent should be first: someone who is either a real estate attorney, a mortgage loan servicer, or a professional title agent.
A fee of about 1% to 2% goes to the escrow agent.
Are There Different Types of Escrow Accounts?
It should be noted that what the opening describes is only one type of escrow account: a real estate escrow account (also known as a pre-closing escrow account), which is typically set up by real estate attorneys and law firms.
Real estate brokerages can also establish escrow accounts to hold deposits for rental applications.
The second type is a mortgage escrow account (sometimes called an impound escrow account, depending on your region).
This second type is established by your mortgage lender to pay, on your behalf, expenses related to your property. We’ll discuss that more in detail later.
An escrow account is necessary to seal the deal.
Mortgage lenders typically insist on a real estate escrow account for the buyer prior to the purchase, which may be before any home inspection or disclosures on the home's condition are completed.
Often, escrow is required for any home purchase to occur.
With real estate, both property and money will be considered "in escrow" before the deal goes through.
The escrow account is liquidated of funds and documents when certain contingencies, such as items identified in a home inspection in need of repair, have been completed.
If such repairs haven’t taken place, the sale process can be paused until those repairs—or any other unmet contingencies—are satisfied.
How does an escrow account exactly work?
In addition to the account, there is an actual escrow agreement. The buyer, seller, and lender are all parties to the creation of the document.
All parties sign the agreement and send it to an escrow agent. This independent agency is not affiliated with any of the stakeholders—including the lender.
The escrow agency, guided by the escrow instructions, will take care of the money and documents accordingly.
The buyer, seller, and lender work together to draft the terms of the escrow agreement.
This document is then signed by all parties and is sent to the escrow agency, a third party that is separate and distinct from your lender.
It is here that the escrow officer will process the funds and documents in accordance with the escrow instructions. It’s the buyer’s or seller’s agent who generally recommends which escrow agency to use.
However, all stakeholders have to consent to use that agency.
If you insist on finding an escrow agency on your own, ask your bank for recommendations.
Once the purchase agreement has been completed, the buyer’s real estate agent will put what’s known as “earnest money” (typically the equivalent of 1% to 2% of the purchase price) into the escrow account.
Some other terms that factor into the release of any money held in escrow is moving forward with title insurance and the signing of the seller’s deed.
The escrow agent then submits the buyer’s loan documents to the lender for a final review and approval of the mortgage—or not.
What happens to the money in escrow when the deal falls apart?
An important section in the escrow agreement is what happens if the sale doesn’t go according to plans—and the home purchase doesn’t close.
If issues arise—such as the seller not being approved for a mortgage—that kill the deal, the seller may be able to keep the earnest money in the escrow account.
If it’s a fault related to the seller that squashes the deal, the buyer may be able to recoup that earnest money.
Anything that unravels the transaction and forces the escrow account to dissolve is referred to as ‘falling out’ of escrow. Every escrow agreement is different, so execute—and read—yours very carefully.
When does the money get transferred from escrow?
The end of the home buying process is called the “closing.” It’s at this point that the escrow account is closed as well.
Once the paperwork has been signed at closing and all other payments due at that time are remitted, the seller's real estate attorney will transfer the funds held in escrow to the seller’s account.
The title of the home has also been lawfully transferred from the seller to the buyer, and the escrow fund is closed.
How Does a Mortgage Escrow Work?
Such accounts are used to assure mortgage lenders that property tax and homeowners insurance payments will be made on time.
In addition to giving your mortgage lender your monthly mortgage payment, you’ll also give the lender the monthly, prorated equivalent of what your insurance and tax payments will be.
The lender deposits those smaller monthly payments into the escrow account, so the proper, total amount will be available for collection by your local government once per year when that payment is due—your lender will make that annual payment, on your behalf, drawn from the escrow account.
Because property taxes can fluctuate, the amount of money held monthly in an escrow account can also vary.
Paying off home insurance early, or a decline in your home’s value can also cause escrow payments in this type of account to vary.
While there are fees involved, overall, escrow accounts are a good thing—meant to provide accountability, surety, and peace of mind for all involved.
Real Estate Brokerages Also Use Escrows for Rentals
As mentioned, escrow accounts can also be used in rental transactions.
When applying to rent an apartment, you may be asked to place a deposit even before you know if you're approved or not.
Normally, this deposit will go into an escrow account established by the brokerage of the agent you are working with.
Depending on the agency, the earnest money may be the entire security deposit or anywhere from $500-$1,000.
You may be asked to pay this amount in a wire transfer, travelers check, or money order. However, credit card payments are increasingly popular as well as electronic payments like Zelle.
According to New York State law, no real estate brokerages are allowed to "co-mingle" funds--meaning that an escrow account must be a completely separate account from the brokerage's other finances.
A brokerage can get into serious legal trouble if they are found to be co-mingling funds.
The primary reason a brokerage is not allowed to co-mingle funds is that money put in the escrow account should be readily refundable and this money is the brokerage's and should not be "touched".
If the funds are co-mingled, this means monies in escrow could theoretically get taken out or paid out to other parties.
How do I protect myself from real estate scams?
If the brokerage is legitimately operating, they should have an exact and clearly-stated refund policy and procedures in the case of earnest money deposits and security.
Make sure you get a full disclosure agreement from the agency before you hand over any money.
However, that is not to say that scam artists don't exist out there.
Scammers are not just your typical street con artist but can also come in licensed real estate or broker form.
Here are some ways you can protect yourself:
Never hand over cash to anyone for a property. This advice is fairly self-explanatory. Nonetheless, it needs to be explicitly stated here as many people still make this mistake.
Never make out a deposit to the name of your agent. It should be made out to a professional brokerage entity. Note: Sometimes a brokerage contains the actual name of a broker.
You can always look up the name of the brokerage to make sure it is a legal entity registered with New York State.
Likewise, you can also look up the name of your broker or agent to make sure they are a licensed professional.
If you make out payment directly to a person, it may be very difficult to not only to get your money back but also ascertain whether that money is going towards the apartment.
Never wire/transfer money to anyone before you see the apartment or house. If you're being pressured to give a deposit before you see the property, run in the other direction.
They may try to suggest that "if you're serious", you will need to put money down right away. If it sounds, fishy, it's best to walk away even if the apartment looks like a dream online.