Buying an Investment Property – Understanding Escrow

One formal definition of escrow describes it as “a deposit of funds or other instruments by one party for the delivery to another party upon completion of a particular condition or event.” Escrow is a complicated process that intimidates many buyers, but it’s intended to protect both you and the person from whom you are buying the house. It’s important to ask questions if you don’t understand what is being done or why it is being done a certain way.

The way escrow is carried out depends on where you live. In some states, escrow companies do the paperwork and transfer the funds. In others, real estate agents and lawyers handle the paperwork and the delivery of funds and title. Regardless of the players involved, the functions are the same. There are three main activities that are going on at the same time during escrow – getting the house inspection, obtaining the mortgage, and handling the escrow paperwork.

The house inspection

The house inspection, from the buyer’s perspective, is both a protection and a negotiating tool. If the inspector uncovers a serious problem with the house, the inspection contingency in the purchase agreement allows the seller to reconsider the deal and withdraw the offer. As an alternative, the buyer may ask the seller to fix the problems, reduce the price of the house, or give a cash credit towards the repairs. And if the seller refuses, the buyer can back out of the deal. When you’re buying a house, you will want an inspector who is licensed, meticulous, and tough. Fees vary, but will average around $250 – $450. In addition to the general house inspection, it’s often worthwhile for you to hire specialized inspectors to perform chimney, sewer, or termite inspections.

Securing the mortgage

Securing the mortgage is the second activity. Ideally, you have already been pre-approved for a mortgage. If you go to a mortgage broker for the loan instead of going directly to a bank or credit union, you can often find more flexible terms and better rates. During escrow, the details of the mortgage are confirmed and documents are signed. It pays to understand the benefits of different kinds of mortgages.

With a fixed-rate mortgage, the interest rate is locked in. This mortgage may be suitable for an owner who intends to keep the property for a long time, as it protects the home owner against interest rate increases and the payment is a constant amount. However, the interest rate will be higher than for other types of mortgages. With an adjustable-rate mortgage, the interest rate and the payment can go up or down according to the prevailing interest rates. This mortgage allows the buyer to benefit when interest rates are low, but it also exposes the buyer to the risk of escalating rates.

The fixed-rate adjustable mortgage has a fixed rate for certain time, anything from six months to five years. Then the rate adjusts, along with the payments. This can be a money-saving option for a buyer who intends to flip the house within a year or two, because the initial interest rate will be low and the house will be resold before the interest adjustment occurs.

The escrow paperwork

As soon as an offer has been negotiated, a huge amount of paperwork demands attention. The secret here is to read all documents carefully, ask questions when necessary, and respond to all instructions immediately.

The inspection and mortgage generate their own paperwork, of course. You must also submit the deposit, negotiate any concessions from the seller, review the title report, review estimated closing cost statements, remove the contingencies, secure property insurance, prepare and transfer funds to escrow, and sign the final documents. Above all, you must be conscious of all deadlines and not wait until the last minute. Missing a deadline or failing to sign a document could unravel the whole deal you’ve worked hard to make.

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