If you’ve never bought a home before, “escrow” may be a new word to you. Even if you’ve heard the term before, you may find it scary or think it’s a bad thing; these tend to be common perceptions among people who don’t fully understand what escrow is or why it’s necessary. Basically, escrow occurs when an amount of money is held by a neutral third party for a certain amount of time, essentially leaving the funds in limbo until some event occurs. During the home-buying process, you will likely have two different amounts of money in escrow for two different reasons: one relates to your transaction with the seller, and the other relates to your home owners insurance and property tax payments.
When you’re ready to make an offer on a house, you’ll probably want to also offer an earnest money deposit, occasionally known as a good-faith payment. This is a standard part of nearly all real-estate transactions, including those involving VA lenders. An earnest money deposit indicates to the seller that your offer is serious and you’re not still looking at a bunch of other homes, and it may give the seller an incentive to make certain concessions in your favor. Once you enter into a purchase agreement and you write the check for your earnest money deposit, that sum is placed in an escrow account with an escrow company that you and the seller have agreed upon. The company safeguards the money until your real-estate transaction is completely finished – neither you nor the seller can touch the money until the time is right. (In certain locations, an attorney will be used, rather than an escrow company.)
Keeping the money in escrow offers assurance for all parties. If you change your mind about purchasing the home for an unapproved reason, the seller will get to keep your earnest money deposit – it’s essentially compensation for them if you cause the deal to fall through. But if the seller pulls out of the transaction unexpectedly, or if you have to pull out of the deal for a reason that’s okayed by your contract, you’ll get your deposit back. Approved contingencies for the buyer to end the transaction might include:
- A major defect is discovered during an inspection of the property
- The appraised value of the new home ends up being less than the purchase offer (this is a contingency for every VA purchase loan)
- You are unable to obtain financing in time to purchase the home by the agreed-upon date
- The deal to sell your current home falls through, leaving you unable to purchase the new home by the agreed-upon date
Usually, once everything is finalized, the earnest money deposit on a conventional loan will be applied to the buyer’s down payment or closing costs. Since VA loans don’t require down payments and sellers in these transactions may pay up to 4% of the value of the loan in concessions, which will likely cover your closing costs, the earnest money deposit on a VA loan deal will either be returned to you or be applied to any portion of your closing costs not paid by the seller. (Note: the act of closing on a home may sometimes be referred to as “escrow,” because that’s when your earnest money deposit comes out of escrow.)
The other escrow situation will likely occur at the request of your VA mortgage lender. It is in the lender’s best interest that you purchase home owners insurance to protect their investment in the event of a disaster and that you pay your property taxes regularly – otherwise the local government can take your home away, and the lender will, again, lose out on their investment. (Note that some states discount or waive property taxes for disabled veterans who meet certain criteria.) As part of your closing costs, your lender will likely require you to deposit money in an escrow account to ensure that you have enough funds to cover your home insurance and property tax payments. There are limits on how much you can be required to deposit; common figures are fifteen months’ worth of insurance payments and three months’ worth of property taxes. When your payments are due, the escrow company will transfer the correct funds to the appropriate recipients.
On VA loans, of course, sellers often pay the buyer’s closing costs, so your seller may cover your up-front escrow for insurance and taxes for you.
The family of VA loan specialists and lenders at Fortress VA Loans knows that all the various aspects of the home-buying process can add up to be quite overwhelming, especially for first-time home buyers. That’s why we work so hard to make things as simple as possible for you. If you still have questions about escrow or any other facet of VA loans procedures, we’ll be very happy to discuss everything with you in detail!
