When buying or selling a property, the real estate escrow process is an essential component of the transaction. The escrow process is a method of ensuring that both the buyer and seller fulfill their obligations and that the transaction proceeds smoothly.
As requested by some of the readers as a continuation of a previous article on What all First-time Homebuyers Must Know , we will explore the real estate escrow process in greater detail and provide an overview of how the entire process works.
Key Takeaways
- What is The Escrow Process and Its Core Benefits
- The Real Estate Contingencies
- The Importance of Earnest Money Deposit
- Property Inspection Period
- Title Search
- Loan Approval and Appraisal Process
- Closing Period
What is Escrow?
Escrow is a legal arrangement in which a neutral third party holds funds and documents on behalf of the buyer and seller. The purpose of escrow is to ensure that all parties involved in the transaction fulfill their obligations before the sale is completed. It is a safeguard against fraud, misrepresentation, and default.
The escrow process begins when the buyer and seller sign a purchase agreement. This agreement outlines the terms of the transaction, including the purchase price, closing date, and any contingencies.
Benefits of having an escrow process
The escrow process provides several benefits for buyers, sellers, and lenders. For buyers, it provides a level of security and ensures that all necessary due diligence is performed before the purchase is completed. For sellers, it provides assurance that the buyer has the necessary funds to complete the transaction and protects against fraudulent payments.
Lenders also benefit from the escrow process. They can be sure that the funds they lend are being used to purchase a property with a clear title and that their lien is properly recorded. This reduces the risk of default and foreclosure.
Now, for the sake of saving time, the beautiful timeline from New Venture Escrow best illustrates the whole process in chronological order below. Keep in mind, depending on the conditions of the real estate market, the length of the process may vary. For example, during the peak of the 2021 housing market, our team successfully closed escrow in 17 days. How? Because we’re good.
Different Types of Contingencies
The word contingency is used even before the escrow process starts. A real estate contingency is a condition that must be met before a real estate contract becomes binding. Contingencies are common in real estate contracts and are designed to protect the buyer from unexpected issues or problems that may arise during the transaction. As a matter of fact, contingencies can simply be compared to promises or due diligence buyers and sellers agree to fulfill within an appropriate time frame.
Contingencies are typically included in the real estate contract and must be met before the contract becomes binding. If a contingency is not met, the buyer may be able to back out of the contract without the penalty. Each contingency will have its own deadline and once the contingency is satisfied by both buyers and the sellers, a formal notice / addendum must be documented.
There are several types of real estate contingencies, including, but not limited to:
- Inspection contingency – This contingency allows the buyer to have the property inspected by a professional inspector. If issues or defects are found during the inspection, the buyer may be able to negotiate repairs or a reduction in the purchase price.
- Financing or Loan contingency – This contingency allows the buyer to back out of the contract if they are unable to secure financing for the purchase. To many buyers, this is the most important item out of all and can make or break a contract.
- Appraisal contingency – This contingency allows the buyer to back out of the contract if the appraised value of the property is lower than the purchase price.
- Title contingency – This contingency allows the buyer to back out of the contract if there are any issues with the property’s title, such as liens or encumbrances.
- Sale contingency (If applicable) – This contingency allows the buyer to back out of the contract if they are unable to sell their current property before the closing date.
Contingencies can provide peace of mind to the buyer and protect them from unexpected issues or problems that may arise during the transaction. However, they can also complicate the transaction and may lead to delays or renegotiations. It’s important for both the buyer and seller to understand the contingencies in the contract and ensure that they are met in a timely manner.
What is Earnest Money Deposit (EMD)?
Once the purchase agreement is signed, the buyer typically deposits an earnest money deposit to the escrow company, which is a sum of money that the buyer puts down to show the seller their commitment to fulfill all the conditions and complete the transaction. The amount of the deposit, though varies, typically is between 1% and 5% of the purchase price depending on the real estate markets that you are in and how competitive it is at the moment.
The Buyer’s EMD is Important for Good Reasons
Like mentioned above, it demonstrates to the seller that the buyer is serious about purchasing the property. This can give the seller confidence that the buyer is committed to the transaction. Additionally, the higher the EMD amount is, the stronger an offer becomes and it will help the buyer’s case especially if the seller has multiple offers at the same time. So Chad, should we just put 10% of the purchase price down as the EMD? Not so fast!
Not only that EMD helps buyers in a purchase transaction but the concept was initially designed to provide some protection to the seller if the buyer defaults on the transaction. If the buyer backs out of the transaction without a valid reason (either cold feet or unable to meet a contingency), the seller may be entitled to keep the earnest money deposit as compensation for their time and expenses. This can also help deter buyers from backing out of a transaction without a valid reason.
And I say it here just like how I said it to many clients, the escrow process is full of surprises. What happens if buyers don’t like the property anymore after the inspection or buyers are no longer qualified for the loan they applied for? Yes, they will lose the entire EMD amount. Therefore, yes, having a competitive EMD amount helps but there’s a risk level associated with it.
Property Inspection
When buying a property, a property inspection is an important step in the due diligence process. A property inspection is a detailed examination of the property by a professional inspector to identify any issues or defects. The inspector will examine the property’s structure, exterior, roof, plumbing, electrical systems, heating and cooling systems, and any other components of the property.
During the inspection, the inspector will look for any issues that may affect the safety or functionality of the property. This may include issues such as structural damage, water damage, mold, pest infestations, or electrical or plumbing issues.
After the inspection is complete, the inspector will provide a detailed report of their findings. This report will identify any issues or defects that were found during the inspection and may provide recommendations for repairs or further evaluation by a specialist such as a roofing inspector or a termite inspector.
Why is a Property Inspection Important?
By helping buyers identify the issues with the property before moving forward, the inspection period can help the buyer make an informed decision about whether to proceed with the purchase or not, renegotiate the terms of the contract or the purchase price of the house, request for repair credits, or completely walk away from the transaction.
A property inspection can provide peace of mind to the buyer. By identifying any issues or defects with the property, the buyer can be confident that they are making a sound investment and can plan for any necessary repairs or maintenance.
Loan Approval and Property Appraisal Process
Many clients, homebuyers, and fellow real estate agents would agree with me when I say this may be the most important item of the escrow process, the loan approval process and the loan contingency. This piece has caused much anxiety to many buyers because it determines whether or not they can move forward with the transaction or not.
When buying a property, the loan approval and appraisal process are important steps in securing financing for the purchase. In this article, we will explore what the loan approval and appraisal process are and why they are important.
Loan Approval
The loan approval process is the process by which a lender evaluates a borrower’s creditworthiness and ability to repay a loan. This typically involves a review of the borrower’s credit history, income, employment history, and debt-to-income ratio.
During the process, the lender will review the borrower’s credit report to assess their credit history, credit score, income, and employment history to ensure that they have a stable source of income and can afford the mortgage payments.
Once the lender has completed their review, they will provide the borrower with a loan pre-approval letter. This letter will state the loan amount that the borrower is approved for, the interest rate, and any other terms or conditions of the loan.
Appraisal
The appraisal process is the process by which a professional appraiser (provided by the lender) evaluates the value of the property. The appraiser will examine the property and review recent sales of comparable properties in the area to determine the fair market value of the property.
During the appraisal process, the appraiser will examine the property’s condition, size, and features. They will also consider the location of the property and any recent improvements or renovations.
Once the appraisal is complete, the appraiser will provide a report that includes the appraised value of the property. This report is used by the lender to determine the loan amount that they are willing to provide for the property. The ultimate result of the appraisal process is extremely important because it will directly affect the loan amount a lender is willing to issue. For most cases, if the appraisal result comes in lower, buyers must either restructure the loan to take out a higher loan amount that they can afford or increase the down payment amount to cover that difference in values.
For a simple example, if the agreed purchase price is $200,000 and the appraised value is $190,000, the worst case scenario will require the buyers to bring an additional $10,000 to closing, the difference in the 2 numbers. Like I said, it’s a simple example so do not shove it down my throat for this!
If you are lucky enough, depending on the purchase price and the structure of the loan (how much Down Payment there is and what is the debt-to-income ratio), the lender may waive it completely without affecting the qualification of the loan.
Why are the Loan Approval and Appraisal Processes Important?
At this point, everyone should understand that the loan approval process can make or break a transaction. Depending on the buyer’s financial situation, sometimes, loan restructure is not a viable option due to unexpected reasons such as a loss of income, not enough reserved funds to cover the appraisal gap, etc. And circle back to the discussion of the EMD amount, if the buyers do not get approved for the loan, they will face the reality of losing that amount if they pass the contingency deadline.
Therefore, it is important to do your homework thoroughly and be financially prepared for the worst possible scenario. Sh*ts happen all the time and none of us can really predict the future. In order to ease the anxiety of obtaining a loan, choosing a compatible loan officer or lender is critical. Just like any other job, anyone can learn and lock in a rate. However, when running into problems, will that loan officer be able to help you overcome those hurdles? That will be a separated discussion.
Here at our team, we have a combined of over 10 years of experience in originating loans so if any reader has any question on loan approval process, feel free to reach out to us at mortgage@chadvorealestate.com
Title Search
While the buyers are busy completing their contingencies, the escrow company must complete perhaps one of the most important steps in the process, Title Search. When you are buying a property, conducting a title search is an essential part of the due diligence process. A title search is a detailed examination of public records to verify that the property being sold has a clear and marketable title.
What is a Title Search?
A title search is an examination of public records to determine the legal ownership of a property and whether there are any liens or encumbrances on the property. The purpose of a title search is to ensure that the person selling the property has the legal right to do so and that the buyer will receive a clear title to the property.
The title search is typically performed by a title company or an attorney. The process involves searching public records, including county land records, court records, and tax records. The title search will reveal any outstanding liens or judgments against the property, any unresolved claims or disputes, and any other encumbrances on the property.
Why is a Title Search Necessary?
A title search is necessary for several reasons. First, it ensures that the seller has the legal right to sell the property. If there are any outstanding liens or judgments against the property, the seller may not have clear title and may not be able to legally sell the property.
Second, a title search protects the buyer from any claims or disputes that may arise after the purchase is completed. For example, if a previous owner of the property had unpaid taxes, the IRS could place a lien on the property. If this lien is not discovered during the title search, the buyer could be held liable for the unpaid taxes.
Finally, a title search is necessary to obtain title insurance. Title insurance protects the buyer and the lender from any defects in the title that were not discovered during the title search. If a defect in the title is discovered after the purchase is completed, title insurance will cover the costs of resolving the issue.
The Closing of Escrow
Well, thank you for reading all the way up to this point! And you might as well just finish the rest.
In escrow, even when all the due diligence items are completed, everyone’s job is not considered to be over yet because the transaction hasn’t been closed! The closing process is an important part of the transaction. This is the time when all paperwork is finalized, funds are transferred, and the deed of trust is recorded. It is a crucial part of the transaction and it is important to understand the steps involved.
During this period of time, the escrow company will finalize all the contingencies and all the agreements have been fulfilled and will coordinate with the lender (in most cases) to schedule a closing appointment for buyers, which will require buyers to go over important documents, sign, and the process must be notarized (for most part since some in California can be done remotely and electronically).
After the signing appointment is completed, buyers must finish their very last task before receiving the keys to their homes, which is to wire the remaining balance of the down-payment and the closing cost to the appropriate party (lenders will provide wiring instructions). Therefore, it is extremely important to make sure buyers will have all the funds liquidated and readily available sometimes before the signing appointment to avoid unnecessary delays.
The escrow company then disburses the funds to pay off any existing liens or mortgages on the property. The remaining funds are then distributed to the seller, real estate agents, and any other parties involved in the transaction. Afterward, escrow company will take 1-2 days to verify all the funds and that the deed has been recorded with the county. Once buyers receive the confirmation, congratulations! You’re now the owners of the subject property.
It sounds simple but I personally witnessed many buyers (not my clients) experienced delays through poor coordination between the lender and the escrow companies. Therefore, it never hurts to make sure either yourselves or your realtors to proactively follow up with all the involved parties to ensure a smoothest closing process.
Conclusion
The real estate escrow process is a critical component of any property transaction. It provides a level of security for all parties involved and ensures that the transaction proceeds smoothly. Whether you are buying or selling a property, understanding the escrow process is essential to a successful transaction. Though it can be a lot to process, I highly encourage all homebuyers or home sellers get familiar with the process to avoid any misinformation.
Of course, if you have any additional question or are interested in our services, you can reach out to our team anytime at info@chadvorealestate.com for the general real estate service and mortgage@chadvorealestate.com for our mortgage department.
Other than that, I wish our readers nothing but the best.
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