There’s a synonym for money put into an escrow account for a home purchase. It’s called earnest money, and the term refers to the good faith of the homebuyer. You pay escrow to seal the deal after a property owner accepts your offer.
While these funds show the seller you’re serious about purchasing the dwelling, if you can’t close the loan, you could lose your escrow money. However, everything depends on your sales contract and the contingencies included.
While you could lose your escrow money if you can't close your mortgage, you can reduce the risk with contingencies in your sales contract.
Defining Escrow Money
Don’t confuse escrow with a down payment. They are two separate parts of a home-buying transaction. Escrow amounts vary according to region, but the money is usually 2 to 3 percent of the home’s purchase price. The down payment is generally larger, perhaps 10 percent or more, with the exception of Federal Housing Administration loans.
If the purchase goes through, the escrow amount is added to the down payment. Prior to the purchase, the escrow money is put in an escrow account by your real estate agent and is not given directly to the seller.
Understanding Financing and Contingencies
It’s always wise to obtain financing from a lender before you go house hunting. That alleviates the risk that after putting down earnest money, you can’t qualify for a mortgage, or you can’t borrow as much as you’ve planned. If your real estate contract includes a contingency that you are able to obtain financing, that should protect your escrow money should you experience an issue with a lender. Without such a contingency clause, your failure to secure a mortgage likely means the seller can keep your escrow money.
Considering Other Contingencies
The ability to obtain financing is not the only contingency that your contract should cover. When you’re buying a home, an inspection and appraisal are part of the process.
The former involves a professional going over the home and ensuring that the house is structurally sound, and all systems are in working order, such as plumbing and heating. Even a new home may have problems, so inspections are crucial. If the property has issues and you decide they are more than you can deal with, the contingency clause should ensure you get your escrow money back.
An appraisal is a different matter where a professional appraiser determines the home’s value by examining the dwelling’s condition and size and comparing it to the price of similar properties recently sold locally. These properties are known as comparables, or "comps." If the appraisal comes in below the agreed-upon selling price, your lender will not finance it for that amount.
Often, you can work with a seller to lower the price, since the same situation will come up with any other buyer. If the seller holds firm, you can try to make up the difference in cash, but that’s not a good idea. No matter how much you love a house, paying more than it is worth is unwise. The contingency in your contract should address the appraisal, allowing you to get your escrow money back if it comes in below the agreed-upon price.
Handling Emergency Situations
If an emergency comes up, such as a sudden job transfer or a death in the family, whether or not you can get your escrow money back depends on the seller. An understanding seller may agree to an escrow refund, but should he decide to keep the escrow, you’re out of luck. A seller may agree to refund part of your escrow if you offer a cancellation fee.