Understanding the Escrow Process

Buying a house can be a complicated process for which most people are generally unprepared. One of those mysterious elements is the escrow process—also called closing—which occurs between the time a seller accepts the offer and the buyer gets the keys. Escrow is a financial instrument held by a third party on behalf of two other parties who are completing a transaction. It's like a trust account held by a third party while all the seller and buyer's obligations are fulfilled.

The time it takes to go from the beginning to the end of the escrow process varies. Some of the factors determining the length of the closing include a mortgage pre-approval, having the proper documents on hand, and the amount of time it takes to get the underwriting complete. And just like the length of time, the process can also vary by state. The steps, however, are generally the same for everyone.

Once you and the seller have signed a mutually acceptable purchase agreement, your agent will collect your earnest money check and deposit it in an escrow account at the escrow company specified in the purchase agreement.

The escrow company acts as a neutral third party to collect the required funds and documents involved in the closing process from the initial earnest money deposit and loan documents to the signed deed. In some areas, attorneys may handle this process instead of an escrow company and it may be called a settlement rather than an escrow.

The bank advancing the mortgage will do its own appraisal—which the buyer usually pays for—to protect its financial interests if it ever needs to foreclose on the property. If the appraisal comes in lower than the offered price, the lender will not give you financing unless you come up with the difference or the seller lowers the price to the appraised amount.

You can, however, try to change the appraiser's mind by doing one of the following:

• Provide additional information on why you believe the home should be appraised at a higher amount
• Get a second appraisal
• Try another lender and hope that appraisal comes out in your favor

If none of these options is possible, you can cancel the purchase contract.

You should have already been pre-approved for a mortgage before your agreement was accepted. Once you give your lender the property address, they will prepare a good faith estimate—or a statement detailing your loan amount—interest rate, closing costs and other costs associated with the purchase. Be sure you negotiate the numbers on this document before you sign it. Once you have your written loan commitment, it's time to remove the financing contingency in writing.

You should receive written notification of any obvious problems that have already been identified by the seller or the seller's agent. For example, in moderate- to low-income neighborhoods in high-cost-of-living areas, the garage may have been turned into a living area in violation of city housing codes. You may already be aware of any problems like these because they're often mentioned in the listing.

The property may come with a no seller disclosure, meaning the seller is not releasing any details in the terms of sale. If you're still interested in the property, have your own inspection done. Make sure you get permission from the seller before your inspector comes on to the premises.

The next step is to consider whether you want the added expense of inspections. While these aren't required, they can come in handy considering your circumstances.

Although it's not a requirement, it's in your best interest to get a home inspection. For a few hundred dollars, a professional home inspector will tell you if there are any dangerous or costly defects in the home. If there are, you'll want to know about them so you can do one of the following:

• Back out of the purchase.
• Ask the seller to fix them.
• Ask the seller to lower the price so you can handle the repairs yourself.

Note that you cannot negotiate any seller concessions here if the contract says you will purchase the property "as is." If the inspection process concludes satisfactorily, you will need to remove the inspection contingency in writing. You'll repeat this step after any other inspections.

You may want to get a pest inspection to ensure the house does not have termites, carpenter ants, or other pests such as roaches or rats. These problems may not be apparent during the day when you've most likely viewed the house and would be a terribly unwelcome discovery after you move in. Any pest problems will need to be rectified before the sale can proceed—assuming you want to continue with the purchase. This is another area where you may want to renegotiate with the seller to pay for the work.

It is sometimes recommended to get an environmental inspection to check for toxins in the home such as mold and asbestos. There can also be problems on the home site like contamination from a location near a landfill, former oil field, dry cleaner, gas station or other environmentally hazardous business. Any problems uncovered in this area can mean serious health hazards and may be expensive to fix.

Areas subject to earthquakes may require a soils report and/or a geologic report to assess the risk of serious damage to the property in the event of such a disaster. You may also want to consider a flood report. If the home is too likely to flood, you won't be able to get homeowners insurance, which means you can't get a mortgage. In some cases, purchasing flood insurance in addition to your homeowner's insurance will solve this problem. In rural areas, a land survey should be done to verify the boundaries of the property. In urban areas, the boundaries tend to already be very clear.

This includes homeowners insurance and any extra coverage required in your geographic area (such as flood insurance). You will be required to have homeowners insurance until your mortgage is paid off. If you want to save a few bucks, choose your own insurance company and shop around to get the best rate. The one the bank selects may not be the one you want.

Both title reports and title insurance are required by your lender. Even if they weren't, you'd want them anyway.

The title report makes sure the title to the property is clear—that is, there are no liens on the property and no one but the seller has a claim to any part of it. Title insurance protects you and the lender from any legal challenges that may arise later if something didn't show up during the title search.

If there is anything wrong with the title (known as a cloud or defect), the seller will need to fix it so the sale can proceed or let you walk away. Depending on where you live, the escrow company and the title company may be one and the same.

It's a good idea to re-inspect the property just before closing to make sure no new damage has occurred and the seller has left you items specified in the purchase agreement such as appliances or fixtures.

At this point, you probably won't be able to back out unless the home has sustained serious damage. However, it's not unheard of for a petty buyer to pressure his or her agent to get the agreement nullified over something insignificant.

At least one day before closing, you will receive a HUD-1 form or the final statement of loan terms and closing costs. Compare it to the good faith estimate you signed earlier. The two documents should be very similar. Look for unnecessary, unexpected or excessive fees as well as outright mistakes.

The closing process varies somewhat by state, but you'll need to sign a ton of paperwork; take your time with and read carefully. The seller will have papers to sign as well. After all the papers are signed, the escrow officer will prepare a new deed naming you as the property's owner and send it to the county recorder. You'll submit a cashier's check or arrange a wire transfer to pay for your downpayment and closing costs, and your lender will wire your loan funds to escrow so the seller and, if applicable, the seller's lender, can be paid.

If you make it this far, you'll finally get to take possession of the home.

Your agent will oversee this entire process, so don't be too concerned if you don't understand every detail. However, in any transaction where you're putting so much on the line financially, it's a good idea to have at least a basic idea of what's going on so you won't get taken advantage of.