Escrow

Escrow is an essential part of any home purchase process. This neutral third party acts as the middleman and coordinates between buyer, seller, and lender to ensure everyone fairly and promptly upholds their end of the bargain. Read on to learn more about escrow and the role it plays in hard money loans.

What Is Escrow?

Escrow is an arrangement in which a neutral 3rd party is hired to hold assets until the terms of an agreement are met. This is most commonly seen in home purchases/sales. An escrow agent is brought on to hold the funds and documents related to the sale in an external account until the sale is complete. When all conditions of the sale are met, the escrow agent disperses the funds and documents to the correct parties.

How Does Escrow Relate to Hard Money Loans?

Most hard money loans are used to purchase new properties, whether investment property loans, bridge loans, or other types of hard money loans. In these transactions, an escrow agent coordinates between all three parties: the buyer, the lender, and the seller. An escrow agent holds all documents relating to the loan and the purchase, including title reports, deed papers, loan agreements, and legal disclosures. During closing, escrow also manages the disbursement of funds.

How Escrow Works

As soon as a hard money loan is signed, the escrow process begins. Generally speaking, it follows these steps:

Step 1: Escrow account is opened

Typically, the lender selects the escrow agent to protect their own interests.

Step 2: Documents are collected

As each new document is drafted, it’s put into the escrow account. This includes the deed, promissory note, insurance, or other documents. Often, these are signed in the escrow’s presence, too.

Step 3: Funds are deposited

Both the lender’s loaned funds and the borrower’s down payment are sent to the escrow account.

Step 4: Escrow closes

Lastly, escrow distributes the funds as needed to the seller, existing lender, and other parties. They also draft closing documents and send copies to all parties.

Real‑World Scenarios

Escrow plays a key role in hard money loans for new property purchases, but that’s not the only type of transaction in which escrow gets involved. Read on to learn more real-world escrow scenarios:

Acquiring a New Investment Property

An investor discovers a new property they’d like to invest in, but they need a loan. They go to a hard money lender and use one of their existing properties as collateral for their new loan. The lender offers a loan of $400,000 and the investor agrees to pay the remaining $50,000 as a down payment.

As soon as the loan paperwork is signed, the lender opens an escrow account. The lender deposits $400,000 into the escrow account and the investor deposits $50,000 plus closing costs. All necessary documents are signed in escrow, then escrow submits the updated deed of trust. Finally, escrow disperses the funds to the seller and lenders of their outstanding debts and issues closing documents to the seller, buyer, and lender.

Fix-and-Flip

A house flipper finds a great deal on a new property to purchase, renovate, and sell. They’re planning on selling the property as soon as it’s renovated so a short-term hard money loan is ideal. They approach a hard money lender who offers a $200,000 loan. $150,000 will go to the purchase of the home and the other $50,000 will be used for renovation.

Similarly to the above scenario, the lender opens an escrow account as soon as loan documents are signed. Both lender and flipper deposit their portio of the funds into the escrow account. Documents are submitted to escrow and signed. Escrow records the new deed. Finally, escrow distributes the $150,000 plus the down payment and closing costs to the seller, as well as the $50,000 renovation budget to the flipper, either in a lump sum or in stages. Closing documents are issued to all.

Escrow FAQs

How long can money be held in escrow?

With traditional home mortgages, funds can get held up in escrow for anywhere from 30-60 days. Much of this time is spent waiting for financing from the bank. This slow timeline is one of the many reasons borrowers turn to hard money loans from Source Capital. As direct lenders, Source Capital moves much more quickly. Escrow for hard money loans typically closes in as little as 10 days.

Who owns the money in an escrow account?

No one “owns” the money in an escrow account. Escrow is intended to act as a neutral third party known as a “trustee”. They hold the money on behalf of all players in the transaction and can only use it for its intended purpose.

What happens to escrow if a sale falls through?

If a sale falls through while it’s in escrow, escrow must be cancelled. This can happen a few different ways. If both the buyer and seller agree to cancel escrow, funds are distributed according to the sale contract. If either party doesn’t agree to cancel escrow, they’ll need to get a court order or arbitration decision detailing what should happen. Once the decision is made, escrow must act accordingly.

What are the differences between escrow in traditional vs hard money loans?

Escrow in hard money loans differs from traditional mortgages in a few key ways. These include:

Faster: Escrow in the hard money loan process can close in as little as 7-10 days.
Less documentation: Because hard money loans require little income verification, if any, there’s less documentation involved in the escrow process.

Can rehab or construction funds be held in escrow?

Yes, escrow plays a key role in fix-and-flips and renovations. In many cases, borrowers borrow both money for the purchase of the home and money for its renovations. Escrow puts the rehab funds aside in a separate account known as a rehab escrow account. Funds are either distributed in a lump sum at closing or regularly throughout the rehab process, as outlined by the loan agreement.

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