Sir Francis Bacon in his work Meditationes Sacræ. De Hæresibus. (1597) wrote this simple phrase: Ista Scientia Postestas Est – Knowledge is power. And while we all acquiesce to the power of this phrase, we all have to agree that gaining knowledge is not as easy as it sounds. Knowledge, in order to be powerful, has to be fed the right information otherwise it's nothing more than trivia.
In my article, I would like to provide the kind of information that fosters knowledge, not just to the professionals of the real estate industry, but also to the “man on the street” that will, at some point, be involved in a real estate transaction. Think of this article then, as a sort of handbook, chock full of intelligent, useful information, about the different terms and processes involving an escrow transaction.
In a real estate transaction, how many questions are exchanged between Buyers, Seller and all the third parties involved in the completion of the transaction? The answer is: A LOT!
Let's start with the most basic of questions. What is “escrow” anyway and what are the duties and responsibilities of an Escrow Holder to begin with?
From the French word “escroue”, an escrow is the arrangement where a neutral third party called an Escrow Holder or Settlement Agent receives and disburses funds and documents for two or more parties to facilitate the transfer of real property from the Seller to the Buyer.
As the neutral third party, The Escrow Holder acts as a depository of instruments (deeds), funds, documents, instructions and reports, in trust, which affords the principals (the buyer and seller) the convenience of being able to act separately, but simultaneously, towards the completion of the transaction.
As a real estate professional, how often have you asked the question is the escrow open? How do you determine whether it really is open or just in the process of being assigned an escrow number which is another euphemism for sitting unattended on your Escrow Officer's desk?
The truth is, an escrow transaction is considered “open” when the escrow officer has received a photo-legible copy of the fully executed purchase agreement and the Buyer's earnest money deposit. This is true even if the principals are not being represented by an authorized agent. The only difference between a transaction with Agents and a “For Sale By Owner” is the absence of a third party facilitator to expedite the transaction for the Seller's benefit. The escrow process remains the same.
And speaking of the Buyer's earnest money deposit, the signed agreement usually calls for a deposit made with “good funds” from an account under the Buyer's name. If the earnest money deposit is made with a check from an account other than the Buyer's, then that “third party” will need to acknowledge that they are, without duress, forking out the money on behalf of the Buyer. This holds true for company checks, even if the company is personally owned and guaranteed by the Buyer.
The Third Party Deposit Instruction is not just meant to instruct the Escrow Holder on how to handle the funds at the close of escrow, it also provide instructions on how to disburse the funds when the transaction cancels. Since the funds didn't come from the Buyer's personal account, the Escrow Holder will require instructions on who to return the funds to, less incurred costs, if any, when the file cancels. In most cases, the funds are released to the Buyer since the Buyer is one of the principals to the transaction. However, there is that rare occasion where the third party wants their money back, hence the Third Party Deposit Instructions. Correctly executed, this document will reduce the Escrow Holder's liability in the event a conflict arises between the depositor and the principal to the transaction.
One of the most commonly ignored items in the Escrow Instructions are the General Provisions. Escrow newbies are told over and over again, “Read your G.P.'s” A good escrow office knows that their General Provisions can, and most likely will, get them out of sticky situations, subverting costly litigation that eat at profits.
For the general Public, an escrow company's General Provisions is a treasure trove of information about your rights and responsibilities as a Seller or Buyer of real property. Think of it as the “fine print” of your escrow instructions and you would be better served if you at least skim through them.
A negotiated agreement between Buyer and Seller involves several conditions commonly called Contingencies. The written completion, satisfaction and removal of a contingency is vital in a real estate transaction minimizing the exposure to potential lawsuits of all parties. The most common contingency is the Buyer's loan unless the Buyer is purchasing with all cash. If this contingency is not completed or satisfied, the lack of the Buyer's loan can cause the entire transaction to screech to a halt. It's simple math: no loan, no funds, no sale.
Contingencies are also time-sensitive. The C.A.R. (California Association of Realtors) form outlines the time limits for each contingency listed. A Seller has just so many days to order reports and disclosures and provide them to the Buyer through escrow while the Buyer has just so many days after receipt to approve said reports and at the same time come up with the funds to close the transaction.
And speaking of C.A.R., in April 2010, the statewide organization, released the new and improved version of the Residential Property Purchase Agreement and Joint Escrow Instructions. Several changes have been the most significant of which is the requirement of the Seller's Statement of Information to be submitted to the escrow holder a few days after the acceptance of the Buyer's offer.
The Statement of Information is a necessary document from both sides of the transaction. From the Seller's standpoint, information derived from this document will most likely avert any delays in the recording process. By checking the information provided against the General Index, a completed S.I. can remove unpleasant items from a title report such as child support liens, tax liens, or credit judgments doing away with unnecessary hand-wringing or foul tempers from either side.
And then there's the Settlement Statement. The Settlement Statement is a complete accounting of all the fees involved in closing the transaction. The “estimated” Settlement Statement is a an approximation of all the fees involved in the transaction. When the estimated closing statement is presented to the Buyer, the statement outlines the funds the Buyer needs to bring in to close the transaction. When presented to the Seller, under normal circumstances, the estimate should reflect an amount that should be a close approximation of the Seller's proceeds. A good Escrow Officer needs to be able to estimate the funds required to close a file without going overboard with the numbers. At closing, when all the other costs and services are paid and the taxes, rents, and HOA dues are correctly pro-rated, the final closing statement should reflect the amounts and fees paid for by both parties and should indicate the actual amount due back to the Buyer as a refund and to the Seller, under normal circumstances, as the proceeds.
Here's an important item to remember. Do keep track of all your documents especially the Final Settlement Statement and copies of the loan documents which should have been provided to you during the course of your transaction. You will definitely need the Final Settlement Statement at tax time. There are costs and fees that are considered tax-deductible, but don't take my word for it. Please consult your CPA.
Keeping copies of your loan documents will save you a lot of heartache in the long run. At the very least, it'll lessen the aggravation when speaking with your lender. In the event you misplace your copies, your Escrow Holder should be able to provide you with a duplicate set, provided the transaction closed within the last seven, in some cases five, years. And even then, they may not be compete. And please review them. Don't be afraid of the thick stack of documents in your possession, you did pay for them after all. So go ahead and review them, and more importantly handle them with care.
And last but not least, don't be intimidated by the escrow process. A good escrow officer, like those of the Master Escrow Team, can help streamline the process and provide that magical key that opens the door to a speedy and successful closing.