Everything You Need to Know About Escrow
Escrow, also known as good faith money, is the amount that buyers pay after their offer is accepted by the seller. The escrow payment proves to the seller that you are, in fact, serious about buying their property. There is, however, a chance that you could lose your escrow payment if the sale doesn’t go as planned.
All About Escrow
Escrow is typically anywhere from 2%-3% of the home’s purchase price; it is not the same as a down payment. Down payments are significantly larger most times, usually more than 10% (not including Federal Housing Administration Loans). The money is held in an escrow account, it is not paid to the seller. In the event that your sale goes through, your escrow payment will be added to your down payment amount. If your sale does not go through, you could very well lose your good faith payment.
Financing & Contingencies
When you are looking to purchase a home, it is a good idea to be approved for financing ahead of time. This will reduce your stress during the closing process. If the buyer accepts your offer and you end up not getting approved for a loan, or it is a loan amount that is much less than you anticipated, you will end up in quite a tough situation and risk losing your escrow. A way to protect your money is to negotiate a contingency. A contingency is a contract clause that allows a party to back out of the sale in the event a certain situation occurs. For instance, you might negotiate a contingency that states that you are able to back out if you cannot be approved for financing. This way, if you get denied, the seller cannot keep your payment.
Other Potential Issues
A lack of financing is not the only problem that could arise, and you would benefit from negotiating some other contingencies as well. When you are purchasing a home, you will need to have it inspected in case there are any major issues that need to be addressed. For example, if the electrical system is not in proper working order, it will be very expensive to repair. As a buyer, you can negotiate a contingency that if your inspection turns up any issues and you don’t wish to cover the costs, you are able to back out of the sale. It is so important that inspections are performed, even on new construction. This way, if your new HVAC system happens to be faulty, you will know right away instead of after moving in. You will also need to have it appraised if you are a seller trying to set a price, although buyers can do their own appraisals if they wish to. Appraisals are done to figure out the value of a property by evaluating a variety of different factors such as square footage and its price in comparison to other similar homes. If the appraisal comes back and it is less than the selling price outlined in the agreement, the lender won’t finance your loan. This is a risk to them since they would be lending your more than the property is worth; if you were to default on payments, they would lose a large amount of money. It is likely that you could negotiate a lower selling price with the homeowner, but if they aren’t willing to budge and you still want the home you could front the extra amount yourself. However, it is not a very smart financial move for you to be paying more for a property than it is valued at. It is a good idea to negotiate another contingency as well; one that frees you from the agreement if the appraisal results in a lower amount than the price set by the seller. This way, you will not be forced to pay the difference and waste your money.
It is always a possibility that something could come up in your personal life that changes your plans and priorities. Perhaps you get a job offer in another state, or you lose a loved one. In cases like this, you will have to depend on the seller having a kind heart since they could very well opt to keep your escrow payment if they want to. Escrow payments are a big part of the home buying process. They provide assurance for the seller but can be a major risk to the buyer if things fall through. This is why buyers can and should negotiate contingencies into their contracts to protect themselves and their money.