Pare, pair and pear. There’s nothing more confusing than words that sound the same but have completely different meanings.

In real estate jargon, “escrow” is such a word. There are three separate and distinct uses for the word “escrow” in real estate and to those unfamiliar with the intricacies of real estate language, they can be fairly confusing.

First, let’s define the word. In lay person’s terms, escrow is a third-party holding tank, usually for money. The reason real estate professionals make frequent use of escrows is that they offer both sides of the transaction neutral territory in which to conduct business.

What are the three escrows of real estate? They are: A broker’s escrow, a real estate property tax and insurance escrow, and an escrow closing. Let’s take a close look at each one:

1). When buyers make an offer to purchase real estate, they often attach a check representing a portion of the cash down payment, sometimes as much as 5 percent of the purchase price. These funds show the seller that you are acting in good faith, and that you are willing to lose this money if for some reason, outside of the contingencies in the contract, you decide not to buy the seller’s home.

The check is immediately deposited into an escrow administered by the seller’s broker or your broker. As you move forward with the contract, you may give your broker additional checks to deposit into the escrow. When you close, the money in the escrow is credited toward your down payment. Most brokers agree that the interest on the money belongs to the buyer, not the seller.

The escrow works because you and the seller trust that the broker will not automatically return or divide the money should something go awry with the process. If there is a problem with the transaction, the money will be held until the dispute is resolved.

2). Lenders often require that you pay 1/12 of your property taxes and insurance premium each month along with your regular mortgage payment. In other words, you make these payments to the lender, and the lender then takes care of paying your property taxes and home insurance premiums.

Lenders call this service a real estate property tax and insurance escrow. When you purchase a home, they often charge a one-time fee of at least $60 to open and manage this escrow. Unless state law mandates it, they will not pay you any interest on the money they are holding.

The reason lenders do this is to protect their investment (the mortgage). If you fail to pay your property taxes, that property tax lien takes priority over the lender’s mortgage. In other words, if your home is sold at auction to pay your property taxes, the lender gets whatever is left, which may or may not cover your mortgage debt. If you fail to pay your property insurance, and your home burns down, you may not be able to repay your mortgage (or rebuild your home).

  1. The third type of escrow is an escrow closing. In an escrow closing, a disinterested third party (often called the “escrow holder”) holds and distributes legal documents and funds on behalf of a buyer and seller. The escrow holder or officer can be a title insurance company, established escrow firm, attorney, bank or S&L, and some states require the escrow holder to be licensed.

Buyers and sellers instruct the escrow holder to release funds and the deed only when certain conditions are met. The escrow instructions are specific. For example, they might spell out the conditions under which the escrow will terminate without closing. Or, they might spell out how real estate taxes will be prorated, or split, between the buyer and seller.

According to Alan Price, Central Division Manager for Chicago Title and Trust, escrow holders: Act as the depository for funds and documents; process and coordinate the flow of documents and funds; keep all parties informed on the progress of the escrow; respond to the lender’s requirements; secure a title insurance policy; obtain approvals of reports and documents from the parties as required; prorate and adjust property taxes, insurance premiums, electrical bills, rents, etc.; record the deed and loan documents, and, maintain the security and accountability of all money in the transaction.

Unfortunately, escrow officers do not take the place of real estate attorneys. According to Richard Klarin, a vice president of Chicago Title & Trust, escrow instructions are fairly standard, but without an attorney, details are not double-checked.

“Buyers who are not represented by an attorney would be well-advised to ask for a copy of the covenants, restrictions and easements to which the title insurance is subject,” Klarin says.

“And in the escrow instructions, the buyer should include that the purchase is subject to the review and approval of any covenants or restrictions and the approval of the location of the easements” he adds.

Published: Feb 6, 2005