Escrow and Closing

What is escrow and why is it necessary?

An escrow is an arrangement in which a disinterested third party, called an escrow holder, holds legal documents and funds on behalf of a buyer and seller, and distributes them according to the buyer's and seller's instructions.

People buying and selling real estate often open an escrow for their protection and convenience. The buyer can instruct the escrow holder to disburse the purchase price only upon the satisfaction of certain prerequisites and conditions. The seller can instruct the escrow holder to retain possession of the deed to the buyer until the seller's requirements, including receipt of the purchase price, are met. Both rely on the escrow holder to carry out faithfully their mutually consistent instructions relating to the transaction and to advice them if any of their instructions are not mutually consistent or cannot be carried out.

An escrow is convenient for the buyer and seller because both can move forward separately but simultaneously in providing inspections, reports, loan commitments and funds, deeds, and many other items, using the escrow holder as the central depositing point. If the instructions from all parties to an escrow are clearly drafted, fully detailed and mutually consistent, the escrow holder can take many actions on their behalf without further consultation. This saves much time and facilitates the closing of the transaction.

The escrow process was developed to help facilitate the sale or purchase of your home. The escrow holder accomplishes this by:

  • Acting as the impartial "stakeholder," or depository of documents and funds.
  • Processing and coordinating the flow of documents and funds.
  • Keeping all parties informed of progress on the escrow.
  • Responding to the lender's requirements.
  • Securing a title insurance policy.
  • Obtaining approvals of reports and documents from the parties as required.
  • Prorating and adjusting insurance, taxes, rents, etc.
  • Recording the deed and loan documents.
  • Maintaining security and accountability of monies owed and owing.

What Each Party Does in the Escrow Process

The Seller

  • Deposits the executed deed to the buyer with the escrow holder.
  • Deposits evidence of pest inspection and any required repair work.
  • Deposits other required documents such as tax receipts, addresses of mortgage holders, insurance policies, equipment warranties or home warranty contracts, etc.

The Buyer

  • Deposits the funds required, in addition to any borrowed funds, to pay the purchase price with the escrow holder.
  • Deposits funds sufficient for home and title insurance.
  • Arranges for any borrowed funds to be delivered to the escrow holder.
  • Deposits any deed of trust or mortgages necessary to secure loans.
  • Approves any inspection reports, title insurance commitments, etc. called for by the purchase and sale agreements.
  • Fulfills any other conditions specified in the escrow instructions.

The Lender (if applicable)

  • Deposits proceeds of the loan to the purchaser.
  • Directs the escrow holder on the conditions under which the loan funds may be used.

The Escrow Holder

  • Opens the order for title insurance.
  • Obtains approvals from the buyer on title insurance report, pest and other inspections.
  • Receives funds from the buyer and/or any lender.
  • Prorates insurance, taxes, rents, etc.
  • Disburses funds for title insurance, recordation fees, real estate commissions, lien clearance, etc.
  • Prepares a final statement for each party indicating amounts to be disbursed for services and any further amounts necessary to close escrow.
  • Records deed and loan documents, and delivers the deed to the buyer, loan documents to the lender and funds to the seller, thereby closing the escrow.

Escrow Instructions

Escrow instructions are written documents, signed by the parties giving them, which direct the escrow officer in the specific steps to be completed so the escrow can be closed.

Typical instructions would include the following:

  • The method by which the escrow holder is to receive and hold the purchase price to be paid by the buyer.
  • The conditions under which a lapse of time or breach of purchase contracts provision will terminate the escrow without a closing.
  • The instruction and authorization to the escrow holder to disburse funds for recording fees, title insurance policy, real estate commissions and any other closing costs incurred through escrow.
  • Instructions as to the prorating of insurance and taxes.
  • Instruction to the escrow holder on the payment of prior liens and charges against the property and distribution of the net sale proceeds.
  • Since the escrow holder can only follow the instructions as stated, and may not exceed them, it is extremely important that the instructions be stated clearly and be complete in all details.

Division of Charges

The method of dividing the charges for the services performed through escrow or as a result of escrow varies from place to place. The fees and service charges to be divided might include, for example, the title insurance policy premium, escrow fee, any transfer taxes, recordation fees and cost in connection with any loan being obtained. Unless there is some special agreement between the buyer and seller as to how these charges are to be paid, local custom will generally be followed in drafting the instructions to the escrow holder as to how they are to be divided.

Closing the Escrow

Once all the terms and conditions of the instructions of both parties have been fulfilled, and all closing conditions satisfied, the escrow is closed and the safe and accurate transfer of property and money has been accomplished

Why do you need title insurance?

To protect possibly the most important investment you'll ever make - the investment in real estate.

A lender goes to great lengths to minimize the risk of lending money for the purchase of real estate. First, credit is checked as an indication of the borrower's ability to repay the loan. Then, the lender seeks assurance that the quality of the title to the property to be acquired and which will be pledged as security for the loan is satisfactory. The lender does this by obtaining a loan policy of title insurance.

The loan policy does not protect the borrower

The loan policy protects the lender against loss due to unknown title defects. It also protects the lender's interest from certain matters which may exist, but may not be known at the time of the sale.

But, this policy only protects the lender's interest. It does not protect the borrower. That is why a real estate purchaser needs an owner's policy, which can be issued at the same time as the loan policy, usually for a nominal one-time fee.

What is the danger of loss?

If the lender has title insurance protection and the owner does not, what possible danger of loss exists? As an example, assume real estate was purchased for $500,000. A down payment of $100,000 is made, and a lender holds a $400,000 mortgage lien, or beneficial interest. The lender acquires title insurance protecting the lender's interest up to $400,000. But the purchaser's down payment of $100,000 is not covered.

What if some matter arises affecting the past ownership of the property?

The title insurance company would defend and protect the interest of the lender. The purchaser, however, would have to assume the financial burden of his or her own legal defense. If the defense is not successful, the result could be a total loss of title.

The title insurance company pays the lender's loss and is entitled to take an assignment of the borrower's debt. The purchaser loses the down payment, other equity in the property that may have accumulated, and the property. And the balance on the note is still due!

Methods of Holding Title

These methods of holding title (vesting) have certain significant legal and/or tax consequences. Advice from an attorney, tax consultant or another qualified professionals recommended.

  • Sole Ownership

    Single man/woman: a person who has not been legally married.

    An unmarried man/woman: a person who was previously married and is now legally divorced or is now widowed.

    A married man/woman as his/her sole and separate property: a married person who wishes to acquire title in his or her name alone. The company insuring title will require the spouse of the married man or woman acquiring title to specifically disclaim or relinquish his or her interest in the property. This is usually done with a grant deed or quit claim deed.

  • Co-Ownership

    Community property: property owned by husband and wife during their marriage. In California real property conveyed to a man or woman is presumed to be community property unless otherwise stated. Under community property law each spouse has the right to dispose of one half of the community property, including transfers by will.

    Joint tenancy: property owned by two or more persons, who may or may not be married, in equal interest, subject to the right of survivorship by the surviving joint tenant. When a joint tenant dies, title to the property is automatically conveyed by operation of law to the surviving joint tenant. Joint tenancy property is not subject to disposition by will.

  • Other Ways of Holding Title

    A trust: an arrangement whereby legal title to property is transferred by the grantor to a person called a trustee to be held and managed by that person for the benefit of the people specified in the trust agreement, the beneficiaries.

How can there be title defect if the title has been searched and a loan policy issued?

Title insurance is issued after a careful examination of copies of the public records. But even the most thorough search cannot absolutely assure that no title hazards are present, despite the knowledge and experience of professional title examiners. In addition to matters shown by public records, other title problems may exist that cannot be disclosed in a search.

What does title insurance protect against?

Here are just a few of the most common hidden risks that can cause loss of title or create an encumbrance on title:

  • False impersonation of the true owner of the property
  • Forged deeds, releases or wills
  • Undisclosed or missing heirs
  • Instruments executed under invalid or expired power of attorney
  • Mistakes in recording legal documents
  • Misinterpretations of wills
  • Deeds by persons of unsound mind
  • Deeds by minors
  • Deeds by persons supposedly single, but in fact married
  • Liens for unpaid estate, inheritance, income or gift taxes
  • Fraud

What protection does title insurance provide against defects and hidden risks? Title insurance will pay for defending against any lawsuit attacking the title as insured, and will either clear up title problems or pay the insured's losses. For a one-time premium, an owner's title insurance policy remains in effect as long as the insured, or the insured's heirs, retain an interest in the property, or have any obligations under a warranty in any conveyance of it. Owner's title insurance, issued simultaneously with a loan policy, is the best title insurance value a property owner can get.