Understanding what escrow is and how it works in real estate

by Erik J. Martin

You want to purchase a home, but you’re concerned about how the money required will be safely held and transferred when the time is right. Fortunately, there’s a process called escrow that can protect your dollars and ensure a smoother transaction with the help of a third party.

“In your typical real estate purchase and sale transaction or refinance, escrow refers to a neutral third party who helps make sure the exchange of money for property interests occurs as an actual safe exchange,” says Zachary Schorr, a real estate attorney for Schorr Law in Los Angeles. “Escrow eliminates the need for the buyer and seller to directly trust each other by providing a neutral agent to handle the transaction and make sure the agreed-upon exchange occurs based on the terms of the parties’ agreement. Almost all arms-length real estate transactions involve the use of escrow to facilitate the closing of the home purchase.”

The escrow process typically begins when an offer is accepted, at which point the buyer will make a deposit, which is held in a trust account by the escrow holder. An escrow account holds all funds associated with the purchase, including the down payment, and closing costs.

“These funds are held by the escrow agent for disbursement at closing once all conditions of sale have been satisfied,” says Alex Shekhtman, founder and CEO of

LBC Mortgage.

But escrow can have more than one meaning for a home buyer/homeowner.

“Escrow after you purchase a home refers to funds held by a third party for the purpose of paying property taxes and homeowners insurance on behalf of the homeowner,” says Tiffany Stevens, founder of Forward Real Estate. “This is commonly conducted by a mortgage lender, who will collect a portion of the homeowner’s monthly mortgage payment and place it in an escrow account. The lender will then use these funds to pay the property taxes and insurance premiums when they are due. This allows the homeowner to avoid the burden of having to pay these bills out of pocket every year.”

There are several advantages associated with using either type of escrow arrangement.

“Escrow provides security for both parties involved since all monies held in escrow must be released only once agreed-upon criteria have been met,” continues Shekhtman. “It provides assurance that no money can change hands until all parties have satisfied their respective responsibilities, and it enables buyers and sellers alike to rest assured knowing that any dispute involving finances can be easily resolved through contractual means rather than legal action.”

Furthermore, using escrow reduces risk.

“An escrow arrangement can help protect both parties from potential fraud or nonpayment,” Stevens notes.

“Escrow arrangements also provide a convenient way for two parties to exchange funds and assets and an easy way to track payments and make sure all terms of the agreement are met.”

Post-purchase escrow through your lender allows tax payments to be spread out over time, making them more manageable and reducing the risk of tax debt. And it can help avoid penalties from missed or late payments, adds Stevens.

But Schorr cautions that with a lender escrow account, you may end up paying property taxes before they are due, which means you may have less cash on hand when you need it.

“In addition, there may be additional fees associated with setting up and maintaining an escrow account. And if the amount of taxes due is higher than expected or if the homeowner does not make their payments on time, the lender could potentially be responsible for the difference,” Stevens cautions. “Also, if the property is sold before the taxes are due, the escrowed funds may not be available to pay the taxes, and the new owner may be responsible for paying them.”

Before committing to any kind of lender escrow agreement, ask plenty of questions, Shekhtman advises.

“What types of fees might I incur? Is my current income sufficient to cover monthly expenses along with my housing payments plus other related expenses? Will I need extra cash reserves if anything unexpected arises?”