Understanding The Escrow Process
Buying a house is full of complications that most people do not understand and are unprepared for. One of those mysterious elements is the escrow process (also called "closing"), which occurs between the time a seller accepts the purchase agreement and the buyer gets the keys to the new house. Below is a 10-step walk-through of the process so you won't be left standing in the rain without a roof over your head wondering what just happened.
1. Go into escrow/under contract and open an escrow account
Once you and the seller have signed a mutually acceptable purchase agreement, your agent will collect your earnest money check and deposit it in an escrow account at the escrow company specified in the purchase agreement.
The escrow company acts as a neutral third party to collect the required funds and documents involved in the closing process, from the initial earnest money deposit to the loan documents to the signed deed. In some areas, attorneys may handle this process instead of an escrow company and it may be called "settlement" rather than "escrow".
2. Await the bank's appraisal
The bank providing the mortgage will do its own appraisal of the property (which the buyer usually pays for) to protect its financial interests in case it needs to foreclose on the property. If the appraisal comes in lower than the offered price, the lender will not give you financing unless you are willing to come up with cash for the difference or the seller lowers the price to the appraised amount.
Your other options to try to change the appraiser's mind are one of the following:
- to provide additional information on why you believe the home should be appraised at a higher amount
- to get a second appraisal
- to try going with another lender and hope that lender's appraisal comes out in your favor
If none of these options is possible, you will be able to cancel the purchase contract. (For more information on pricing a new home, read 10 Tips for Getting a Fair Price on a Home.)
3. Secure financing
You should have already been preapproved for a mortgage at the time your purchase agreement was accepted. Once you give your lender the property address, it will prepare a good faith estimate, or a statement detailing your loan amount, interest rate, closing costs and other costs associated with the purchase. You may want to negotiate the numbers on this document before you sign it. Once you have your written loan commitment, it's time to remove the financing contingency in writing.
4. Approve the seller's disclosures
During this step, you should receive written notification of any obvious problems that have already been identified by the seller or the seller's agent. For example, in moderate- to low-income neighborhoods in high-cost-of-living areas, the garage may have been turned into a living area in violation of city housing codes. You may already be aware of any problems like these because they're often mentioned in the listing.
5. Obtain the necessary inspections
You aren't required to obtain a home inspection when you purchase a home, but it's in your best interest to do so. For a few hundred dollars, a professional home inspector will tell you if there are any dangerous or costly defects in the home. If there are, you'll want to know about them so you can back out of the purchase, ask the seller to fix them, or ask the seller to lower the price so you can handle the repairs yourself. Note that you cannot negotiate any seller concessions here if the contract says you will purchase the property "as is". If the inspection process concludes satisfactorily, you will then need to remove the inspection contingency in writing. (You'll repeat this step after any other inspections.)
If the lender does not require a pest inspection, you may still want to get one to ensure that the house does not have termites, carpenter ants, or other pests such as roaches or rats. These problems may not be apparent during the daytime hours when you've most likely viewed the house, and would be a terribly unwelcome discovery after you move in. If there are any pest problems, they will need to be rectified before the sale can proceed (assuming that you want to continue with the purchase). This is another area where you may want to renegotiate with the seller to pay for the work.
It is sometimes recommended to get an environmental inspection to check for toxins in the home such as mold and asbestos. There can also be problems on the home site, like contamination from a location near a landfill, former oil field, dry cleaner, gas station or other environmentally hazardous business. Any problems uncovered in this area can mean serious health hazards and may be prohibitively expensive to fix.
Areas subject to earthquakes may require a soils report and/or a geologic report to assess the risk of serious damage to the property in the event of such a disaster. Many areas require flood reports. If the home is too likely to flood, you won't be able to get homeowners insurance, which means you can't get a mortgage. In some cases, purchasing flood insurance in addition to your homeowner's insurance will solve this problem. In rural areas, a land survey should be done to verify the boundaries of the property (in urban areas, the boundaries tend to already be very clear).
6. Get hazard insurance
This includes homeowners insurance and any extra coverage required in your geographic area (such as flood insurance). You will be required to have homeowners insurance until your mortgage is paid off (and you'd probably want it, anyway). Choose your own insurance company, which may be different than the one the lender selects, and shop around to get the best rate. (To read more about necessary insurance, see Beginners' Guide To Homeowners Insurance, Insurance Tips For Homeowners and Five Insurance Policies Everyone Should Have.)
7. Acquire the title report and title insurance
These are also required by your lender, but again, you'd want them anyway. The title report makes sure that the title to the property is clear - that is, that there are no liens on the property and that no one else but the seller has a claim to any part of it. Title insurance protects you (and the lender) from any legal challenges that could arise later if something didn't show up during the title search. If there is anything wrong with the title (known as a cloud or defect), the seller will need to fix it so the sale can proceed or let you walk away. Depending on where you live, the escrow company and the title company may be one and the same.
8. Do a final walk-through
It's a good idea to re-inspect the property just before closing to make sure that no new damage has occurred and that the seller has left you items specified in the purchase agreement, such as appliances or fixtures. At this point in the process, you probably won't be able to back out unless the home has sustained serious damage. However, it's not unheard of for a petty buyer to pressure his or her agent to get the agreement nullified over something insignificant.
9. Review the HUD-1 form
At least one day before closing, you will receive an HUD-1 form, or the final statement of loan terms and closing costs. Compare it to the good faith estimate you signed earlier. The two documents should be very similar. Look for unnecessary, unexpected or excessive fees as well as outright mistakes.
10. Close escrow
The closing process varies somewhat by state, but you'll need to sign a ton of paperwork, which you should take your time with and read carefully. The seller will have papers to sign as well. After all the papers are signed, the escrow officer will prepare a new deed naming you as the property's owner and send it to the county recorder. You'll submit a cashier's check or arrange a wire transfer to pay for your down payment and closing costs, and your lender will wire your loan funds to escrow so the seller and, if applicable, the seller's lender, can be paid.
If you make it this far, you'll finally get to take possession of the home.
Your agent will oversee this entire process, so don't be too concerned if you don't understand every detail as long as you trust your agent. However, in any transaction where you're putting so much on the line financially, it's a good idea to have at least a basic idea of what's going on so you won't get taken advantage of.