Whenever you make a big purchase, there’s a lot that can go wrong. Nobody wants to stress about money, let alone risking your life savings.
Escrow services attempt to make the process as smooth as possible. And while many would rather avoid paying that 1% fee, it costs even more not to protect your transaction. The more money you move, the more expensive the mistake is.
So how does escrow solve this problem?
How Does Escrow Balance Work?
Escrow companies hold both parties’ money until you meet the transaction conditions. And to get this service, both need to meet these financial responsibilities:
- Both parties have to create a mutual written agreement to introduce the third party
- The buyer will offer an “escrow cushion” to cover unexpected costs (e.g., tax increases). If this expense happens to be lower than the amount provided, the escrow agent has to refund the remaining funds
- Both parties will credit the escrow company for managing the transaction (typically a flat fee of $150-$300 plus ~1% of the transaction value, lower for purchases above $1 million)
The most common escrow example is buying a property with a mortgage. First, you agree to offer the seller an earnest amount, proving yourself as a serious buyer. After both parties sign the contract (and verify all documents), you can create the escrow account.
The escrow balance is the money you set aside so that the third party can pay on your behalf. Your escort account will show an amount that you’ll have to pay every month. These payments continue until the house is paid in full.
Whether you pay monthly or the full amount, it shouldn’t change the service terms. What matters is not to miss the monthly minimums (unless you paid more in other months).
This video shows how to read an escrow statement:
3 Benefits Of Using Escrow Services
Some people consider them essential for most major transactions, while others see them as unnecessary. Whether you need them or not depends on how you weigh the benefits.
For both parties, risk management becomes more important when trading large sums of money. That’s why most sellers will include escrow agents by default.
Especially when borrowing money, you will be required to use an escrow account. It’s not that you can’t opt-out, but it’s not easy:
- You’ll need to send a written request to your mortgage lender or agree with the seller directly
- You need to put down at least 20% of the property value (if borrowing 80% of the total or more)
- If your downpayment is lower than 20%, you pay another 0.25% fee to waive the escrow account
Here are other safe payment methods (online and offline).
Assuming you get rid of escrow, you’re now dealing with a complex tax situation.
Since they charge you for not using escrow, you can see why it makes sense to keep it. You’re not saving much money from removing this feature. So why not keep this layer of protection?
When using escrow accounts, the agent takes care of payments from that moment. You don’t need to worry about when to pay, how much to send, or where to transfer. You’re also delegating the management of property taxes, so you can instead focus on your purchase.
If you’re doing it all yourself, it’s easy to get overwhelmed. This leads to the third benefit.
It Frees You From Stress
The escrow service commits to execute the transaction exactly as described. This means that if any of both parties make a mistake, it simply won’t go through.
When risking a lot of money, this relief is priceless. It means the other party cannot take advantage of you. It also protects you from dumb mistakes, so you can’t mess up the deal.
How Much Are Escrow Fees?
Depending on the trading volume, your fees will change. All companies apply base and percentage fees, which reduce when moving larger sums:
- Base fees range from $150 to $450. Also, the company may require a minimum transaction value of $5,000
- Percentage fees can be as high as 2% (for small purchases) and as low as 0.2%. The average rate is somewhere between 0.65% and 1.5% (1% for simplicity)
While that’s a lot of money, it’s negotiable. When escrow is mandatory, the buyer can ask the seller to discount these fees. Otherwise, it’s standard practice to split 50% of the costs.
You pay these fees on your first deposit along with the goodwill deposit. The seller does the same and agrees to sell the asset at its price minus your downpayment.
Mind that your agent will still require an escrow cushion. This extra money serves to manage expenses that change throughout the agreement. If everything goes like clockwork, you get this refunded later.
Let’s say you think property taxes will increase soon. If you pay more every month, you’ll end the agreement sooner, hopefully before your closing costs increase.