After a home seller has accepted an offer from an interested home buyer, the next step is to open escrow — a neutral third party that holds on to funds until the buyer, seller, and lender have all fulfilled their agreements.
An escrow agent maintains an account of all money, contracts, and documentation relevant to the sale. Escrow protects both sides of the transaction by ensuring that all requirements are met before funds are disbursed.
Escrow minimizes risk to the buyer, seller, and lender by ensuring:
- The seller is the true legal owner of the house, and thus qualified to sell it
- No liens or claims from outside parties complicate the sale
- The buyer financially fulfills their side of the contract
One way that an escrow agent determines that the buyer can financially handle the contract is by collecting a small percentage of the home’s sales price as an Earnest Money Deposit (EMD), aka “good faith money.” The buyer and seller negotiate on a percentage of the home’s sale price and the buyer then pays this money into escrow via check or wire transfer.
Neither the buyer nor the seller can touch money in this escrow account until all parties meet their agreements; the deal is finalized; and escrow closes.
When escrow closes, funds are disbursed from the escrow account to the seller. There are exceptions to this, for example when a repair the home seller agreed to complete wasn’t finished before closing. In that case some of the funds can be held in escrow until the repair is completed.
The earnest money deposit then goes toward the down payment.
Once all funds have been disbursed and escrow is closed, read your closing statement carefully and then file it somewhere safe. You’ll need it when you file your taxes.