Mortgages & Home Loans Financing Your Home Purchase What Does Escrow Mean in Real Estate? How Escrow Affects Homebuyers and Sellers By Hayley M. Abernathy Hayley M. Abernathy Hayley Abernathy is a freelance writer and editor with over five years of experience. She has a passion for all things related to real estate and homeownership. That passion grew from a love for house-hunting and home improvement, plus the successes and mistakes of her own homeownership journey. Hayley has a bachelor's in English literature from Bryan College, with minors in writing and Spanish. learn about our editorial policies Updated on July 6, 2022 Reviewed by Doretha Clemon Fact checked by Gina LaGuardia Fact checked by Gina LaGuardia Gina LaGuardia has more than 25 years of experience in senior editorial roles, and is an expert in personal finance topics, including banking and lending. She has created content for financial powerhouses such as Chase Bank, American Express Canada, First Horizon Bank, BBVA, and SoFi. learn about our editorial policies In This Article View All In This Article What Is Escrow? Reasons You Need To Use Escrow Accounts How Escrow Works in Real Estate Understanding Escrow Statements The Cost of Escrow Fees Photo: svetikd / Getty Images If you’re purchasing or selling real estate, you’ll likely hear about escrow—an arrangement commonly used to manage funds after an offer has been accepted on a home sale. Learn what escrow is, what it commonly looks like in real estate transactions, and why that matters for buyers and sellers. Here are some reasons for using escrow accounts, how they work, and what they may cost. Key Takeaways Escrow is an arrangement between two parties in which a transaction is handled by a neutral third party that manages how and when funds are disbursed.Escrow in real estate is used to manage earnest money, distribution of funds at closing, and payments for property taxes and insurance by mortgage servicers.The use of escrow accounts offers significant protection for homebuyers and mortgage lenders.An escrow agent facilitates the closing of a home sale and disperses all the funds to the appropriate parties. Escrow fees may range between 1% and 2% of a home’s purchase price. What Is Escrow? In short, escrow is an arrangement between two parties in which funds or property are managed by a neutral third party that keeps those funds or property safe and manages how and when they are disbursed. Escrow can be used for other transactions besides the sale of real estate. However, in real estate, escrow is most commonly used to manage related transactions, including earnest money deposits before a sale closes, the distribution of funds at the sale’s closing, and the funds and payments needed for property taxes and insurance after the sale. Reasons You Need To Use Escrow Accounts At different stages of a home purchase, the use of escrow accounts (sometimes called “impound accounts”) has benefits for the homebuyer and if the home is financed, the mortgage lender. Protection for Buyers The first way escrow is commonly used in real estate is to hold earnest money. This is a deposit made by a buyer after signing a purchase agreement, and it demonstrates a serious intention to buy. Note As a buyer, if deal requirements are not met, you can recoup your earnest payment, but if you break your agreement for a reason not specified in the contract, you will forfeit your deposit. Protection for Lenders Another way escrow accounts are commonly used in real estate is by mortgage lenders. After a home sale is completed, rather than rely on the borrower to pay property taxes, mortgage insurance, and home insurance premiums on time, many lenders add the estimated costs into monthly mortgage payments. The mortgage servicer then deposits these “extra” funds into an escrow account and takes responsibility for paying the bills on time. So how exactly does this process help protect the lender? Let’s look at two scenarios. Scenario 1: Miguel, the buyer, procures a mortgage to purchase a home. His lender does not require an escrow account, so he simply pays his monthly mortgage payment (principal plus interest). But money is tight, so Miguel doesn’t save for taxes and insurance premiums, and cannot pay them. Money gets tighter, Miguel no longer makes mortgage payments, and it’s time to foreclose. Since the house was collateral, the lender can sell it to make up the unpaid portion of the loan. Now, however, there’s a lien on the property for back taxes. In order to sell, the lender has to resolve the lien, costing extra time and money. Scenario 2: Another buyer, Haleigh—also responsible for paying her own taxes and insurance without an escrow account—keeps up mortgage payments and taxes but neglects to pay home insurance premiums. Coverage lapses. So when her home is destroyed in a fire, not only does Haleigh lose everything without insurance to pay for rebuilding, but the now-vacant property is no longer sufficient collateral to help the lender recover the balance of her loan. How Escrow Works in Real Estate Now that we know why escrow is important in real estate, let’s look at some of the specifics you may encounter in the home sale process. Using Escrow for Earnest Money If you’re buying a home and making an earnest money deposit, ask your real estate agent about their typical process for this. Some real estate agents and brokers may manage the escrow process for you; you may need to set up escrow for yourself; or the title company you plan to use for closing may handle the deposit. Note If you pay an earnest money deposit directly to a seller, it could be very difficult to retrieve that money if the sale falls through. Both buyers and sellers should make sure the purchase agreement specifies the conditions if the earnest money is returned or forfeited. For example, if the sale falls through due to issues found on an inspection, will the buyer receive the deposit back? What about if financing falls through? When it’s time for the sale to close, the earnest money will be released to count toward the total purchase price. Until that point, using escrow protects the buyer’s deposit. Using Escrow for Ongoing Taxes and Insurance Premiums Many lenders require escrow, and in some cases, escrow may be legally mandated. If your lender does require escrow, the mortgage servicer will manage the escrow account and pay the taxes and insurance fees when they are due. Note Even with escrow, you will likely still receive notices of property taxes and insurance premiums. The statements may say that they are not bills, and that your lender has already been notified. If you’re not sure whether the lender has been notified, however, it’s a good idea to contact your mortgage servicer. Understanding Escrow Statements Lenders are required to give borrowers their closing disclosure documents at least three days before a sale closes so buyers have time to review details of their financing and ask any questions. When escrow is included in the loan, these documents will include an initial escrow disclosure statement. You should see the following projections on your initial statement: Total monthly paymentBreakdown of monthly amounts for principal, interest, and escrow fundsAnticipated monthly escrow paymentsEstimated disbursements (payments from escrow for taxes and insurance)Anticipated running balance Moving forward, you should also receive an annual escrow statement from the lender detailing the previous year’s account activity and current balance, as well as projections for the next year. This statement should also specify what will happen to any surplus or how potential shortages will be resolved. Note Mortgage servicers are allowed to keep a cushion in the escrow account of up to one-sixth of what they anticipate to be the annual total needed to pay the taxes and insurance. When there is a surplus in the account at the end of the year, you may receive a refund from your servicer for that amount. If Your Lender Doesn’t Require an Escrow Account If your lender doesn’t require you to have an escrow account, it’s a good idea to request one. That way, you’re not surprised or unprepared when the time comes to pay taxes and insurance premiums, which can be hefty. If you need to open your own account, contact the bank of your choice to let them know. They’ll collect pertinent details and help you set it up. The Cost of Escrow Fees When closing day arrives, a portion of the closing costs will go toward escrow fees. Depending on the sale, these may be paid by the buyer, the seller, or both. These fees go to a third party called an escrow agent, whom the buyer and seller have agreed to use to facilitate the paperwork, closing process, and disbursement of funds. This takes place beginning with the signing of the purchase agreement all the way until the keys are handed to the new homeowner. This escrow agent might be an attorney, a title company, or an escrow company. Cost will vary depending on location, the escrow agent, and the terms of the sale. However, common estimates of escrow fees are 1%-2% of the purchase price of the home. Frequently Asked Questions What does it mean for a house to be ‘in escrow’? “In escrow” is a legal term that means a buyer and seller have signed a purchase agreement, agreed to terms of the future sale, and an escrow account has been opened to hold the earnest money until the title has been transferred to the new owner at closing. How long does escrow take? There is no defined length of time for how long a house must stay in escrow, although usually, a purchase contract does specify a closing date. How long it actually takes to close depends on factors such as financing details, an appraisal, a title search, inspections, and more. A house is no longer in escrow once all closing documents have been signed and the title has been transferred to the new owner. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning! Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. HomeLight. "Escrow Costs Revealed: Sellers May Pay These Fees at Closing.” Consumer Financial Protection Bureau. "What Is an Escrow or Impound Account?” Cornell Law School. “Earnest Payment.” ATG Title. "Who Holds Earnest Money, Title Companies or Agents, and Why." Consumer Financial Protection Bureau. “What Is a Closing Disclosure?” Consumer Financial Protection Bureau. "Guide to Closing Forms," Page 4. Consumer Financial Protection Bureau. "1024.17 Escrow Accounts." American Financing. "Escrow Closing Costs and Other Third-Party Fees: What You Should Know." Inman. “Escrow.”