What To Know About Escrow

The basic concept of escrow is to assure that both the buyer and the seller are protected during any real property transaction.  To this end the services of a neutral third party are employed.  Generally speaking, an escrow agent’s primary responsibility is to act as a trustee of funds and documents deposited with them and to follow the escrow instructions accordingly and make the proper disbursement of said funds and documents.  In California, escrows are performed by Banks, Savings & Loans, Title companies, as well as Independent Escrow firms which are licensed by the State of California.

WHAT IS ESCROW RESPONSIBLE FOR?

An escrow is said to be “opened” when ALL signed Instructions are Returned With Deposit of Funds to Escrow.  In addition to its primary function as an intermediary to follow the escrow instructions among buyer, seller, lender and realtor, escrow’s other responsibilities involve computing a pro-ration of taxes, fire insurance, homeowner’s association dues, interest, etc., as well as, ordering payoff statements (demands) in the case of a refinance or debt consolidation loan, requesting beneficiary’s (Lender’s) statements if needed, preparing documents to transfer the interest of the Seller to the Buyer, calculating the estimated funds needed to close, facilitating loan signings for a Lender, complying within the time limits imposed by the instructions, disbursing funds and documents and providing Buyer, Seller, Lender, and Realtor with copies of the closing statement.  When these duties have been satisfied the escrow is said to have “closed”.  Among the reasons why escrows don’t close as planned are that no one informed the escrow agent that the escrow was contingent upon the closing of another escrow or that the escrow was to close concurrently with another escrow.

BUT, WHAT IF…

If, for some reason, all instructions cannot be carried out by the end of the time limit, all parties involved are entitled to the return of documents, fees, funds and other related materials.  On the other hand, they may mutually consent to extend the time period by changing the instructions. 

TIPS

1. If you have a question, have your escrow number handy.  It expedites responding to your inquiries and needs.

2. Identify yourself immediately.  (Escrow information can only be given to the parties involved in the transaction).

IMPOUNDS CONFOUND BUYERS AND BALLOON CLOSING COSTS

As previously mentioned, escrow is charged with computing a pro-ration of taxes, fire insurance, homeowner’s association dues.  This brings us to one of the most confounding aspects of buying a home—taxes.  Initially, it seems pretty straightforward but then things start to deviate from the rational.  And, it is where escrow starts to really earn their money.

As most of you know the State of California’s fiscal tax year begins on July 1 and ends on June 30.  As such property taxes are a broken up into two six-month installments:  the first half is from July to December and the second half-year installment is for January through June.  The tax authorities like to get your money a bit up front, so the July-December payment is levied and due on November 1st and becomes delinquent a little over a month later on December 10th.  But then, the January-June installment jumps up the due and payable date by two months to February 1 and pushes back the delinquency date, not by a month and ten days as they did in the first half, but instead by 2 months and ten days to April 10th.

If escrow closes on or after November 1 most lenders require that the 1st installments are to be paid through escrow.  If escrow closes on or after February 1st, the lender will usually require that the 2nd installment of taxes be paid through escrow, if they have not been paid.

It gets crazier still when one is establishing an impound account with the new lender.  If a buyer’s transaction closes in October the lender will collect 9 months of taxes but if the buyer closes in February only 1 month of taxes is required.  Incidentally, taxes are assessed on March 1.  If you buy a property in say September the tax bill be for the old assessed rate and the buyer will receive a bill for supplemental taxes (at the new rate because of the presumably higher purchase price) but it will apportioned at .0833 per month based upon the number of months remaining until the end of the tax year, June 30.  In this case it would be .833 x 10 months or .83.

In the event the taxes are not paid on a property the tax bill is stamped “Sold to State”.  If “Sold to State” appears on a tax bill, it is an indication of delinquent taxes for one or more year.  To redeem the property it will be necessary to pay the following (a) delinquency penalties, (b) costs, (c) redemption penalties, and (d) a redemption fee.

FIRE INSURANCE

Often when buying a home borrowers are surprised to find out that loans in excess of 80% of the appraised value, and all government loans (FHA and VA loans) require impounds for taxes, insurance and mortgage insurance.  They are further surprised to discover that they must not only prepay a year’s worth of fire insurance, but also establish an impound account with 2 months of prepaid premiums.  When the annual premium is due again in 12 months, the lender pays the premium out of the borrower’s escrow account. Typically, the borrower’s first mortgage payment will not be scheduled until the second month following closing, which means there will be only 10 installments in the account when the annual premium is due again.  For this reason the lender will collects 2 months reserves at closing.

MORTGAGE INSURANCE

If your loan requires mortgage insurance, escrow will require 2 months of mortgage insurance premiums as the norm.  Again, the lender will escrow 2 months of the mortgage insurance premium to cover the initial 2 months when no mortgage payment is made.

HOA DUES

Like taxes, they are pro-rated, but unlike taxes escrow normally only collects two months worth.

FIRPTA & CAL FIRPTA—GOVERNMENT IN YOUR POCKET

Foreign Investment in Real Property Tax Act, (FIRPTA) requires Federal withholding of 10% of the sales price, regardless of the amount of profit from the transaction in the event that a foreign person would sell U.S. real estate and forget to file a U.S. income tax return.  Similarly, California FIRPTA requires 3 1/3% withholding for "foreign persons" (which includes all non-Californians, including US citizens moving to another State).

The required payments are deposits on any tax liability owed. Like payroll tax withholding, this money is not lost; it is a deposit on actual tax owed. If too much is withheld, the overage will be refunded the following April by filing form 1040NR.  If no tax is due, the entire deposit will be refunded.

Previously, where withholding was required under CAL FIRPTA, a Seller had to withhold 3 1/3% of the property's gross sale price. Now, for all transactions closing on or after January 1, 2007, a Seller may choose between the original withholding method or elect an alternate withholding amount based on the Seller's estimated gain. The alternate withholding amount will be based on the calculation of applying the maximum tax rate to that Individual or Entity, as Seller, to the Seller's estimated gain.

Escrow is essentially a hired intermediary that exists to protect the interests of principals in real estate transactions involving purchases and refinances.  Its other primary functions are to attend to the various housekeeping chores associated with them such as pro-rations for interest, impounds for insurance and taxes, HOA dues, mortgage insurance, various state and federal withholdings, and the balancing these general accounts.

Copyright © 2020 Rod Haase.  All rights reserved.