Title Company vs. Escrow
Buying real estate can be a good investment or a personal milestone, but a real estate transaction is not just a simple agreement. It has financial and legal implications that involve numerous parties. Two of them are these typically confused terms – Title Company vs Escrow.
These two terms are mistaken for each other due to the overlap in processes involved. A title company and escrow company administer the real estate transaction together, and the process does not have to be complicated if you consult your real estate attorney early on. Combined, they protect the buyer and seller from malicious acts out of their control.
Buying your next house doesn’t need to be complicated, but it does need to be secure. A title and escrow are responsible for doing just that.
An escrow is a legal arrangement that puts earnest money into the trust of a third party during an ongoing transaction. These escrow funds will be kept until the escrow process is concluded and the contract is fulfilled by both the buyer and seller.
Escrow services create two intangible benefits for both parties involved. One, it assures sellers that the buyer is committed to closing. And second, it allows buyers to perform their due diligence checks and searches that fulfill the conditions in their contract.
At the onset, an escrow account is where the earnest money is held.
But, upon closing, an escrow account is established to facilitate mortgage and tax payments. Each month, mortgage payments are deposited into the escrow account, and the money will be used to pay property taxes, mortgage, and insurance policies associated with home ownership.
Your lender and mortgage servicer can be different parties, but the latter will facilitate this process. Especially for first-time house buyers, budgeting and paying for these costs can be a hassle on top of the whole real estate transaction.
With an escrow account, not only are you free of all this work, but you can also disperse the payment over the year, so it becomes more affordable as a buyer and homeowner.
An escrow company is a neutral third party protecting the money and interests of the parties involved. They are responsible for two duties which are to handle the funds and prevent the buyer from accessing the deed as well as prevent the seller from accessing the money until the contract is fulfilled.
In some transactions, the real estate attorney handles this process instead of an escrow company. This is called a settlement, not an escrow.
The existence of this third party is necessary to build confidence and trust in the real estate transaction, so we get closer to a sale without the fear of malicious acts.
The escrow process starts when a seller accepts a buyer’s offer for their house. A mutually acceptable purchase agreement is then signed, and the real estate agent collects the earnest money, and a deposit of good faith to show commitment to the sale. These escrow funds are kept by the escrow company as represented by an escrow agent until the contract is executed.
If you acquired a loan to fund your purchase, you need to wait for the bank or other lender provider for their own appraisal. The costs of which are paid by buyers.
The appraisal is necessary to protect the lender’s interests if the property will ever be foreclosed. The lender will conclude if the value of the property is what is indicated and agreed upon.
For example, in the event that the lender’s appraisal does not match that of the seller, the financing will be limited to the appraised amount. The buyer will have to shoulder the difference. The difference can be minimal depending on whether the seller is willing to decrease the price closer to the appraised amount.
This does not mean it’s a done deal, because you can still provide additional information and documents for why the house is worth more money. Other alternatives include getting a second appraisal or another lender whose lender’s policy is more in line with the value you envision.
Ideally, a buyer should have a pre-approved mortgage upon purchase agreement. Once the lender is notified of a property’s address, they will prepare documents detailing your loan amount, interest rate, closing costs, and other fees related to the real estate transaction.
Other than a loan, insurance will also protect buyers from unforeseen costs. For example, hazard insurance covers natural disasters.
If your contract had a financing contingency as a clause, you can tick it right off when you have secured your loan, and you’re one step closer to dangling your home key!
At this stage, the seller prepares written documents detailing obvious and known problems with the property or issues identified by the real estate agent. For example, there may be legal implications to house renovations, such as turning a garage into a living space which is in contrast with city housing codes.
This step is not required, but it does protect the buyer’s best interests. The following are inspections that will help build your dream home:
Pest Inspection – rectify any pest problems and negotiate the fees with the seller before proceeding with the sale. Pests can incur long-term costs and can decrease the value of a property.
Environmental Inspection – toxins around the house can also damage the property and your well-being. Check for nearby contaminations and ensure that your right to a healthy environment as a buyer is protected. Additional environmental considerations may include testing for water quality (especially important if the water is supplied from a well), as well as oil or sewage leaks (for homes with heating oil or septic tank infrastructure).
Other inspections – some areas need a geologic report to protect buyers from buying a property at risk of earthquakes, floods, and other natural disasters. If the house is at high risk, it can decrease your chances of acquiring homeowner’s insurance and, consequently, a mortgage.
The closing process may differ per state, but the commonalities include documentation of the agreements, signing a deed to represent renewed ownership, and detailing the closing costs.
A title is a document representing your rights to a property. In a real estate transaction, this right is transferred from the seller to the buyer upon the fulfillment of all contingencies and stipulations in the contract.
The rights protected can range from the ones detailed in public records, to enforceable laws, and transfer of ownership regulations.
Title companies issue title insurance that protects the homeowner’s rights and interests. Other than that, they also provide escrow services, closing services, title searches, and title issuing.
Similar to escrow services, title companies are also a third party during the transaction. They begin to gather information and documents on the history of a title or chain of ownership once the transaction starts. They inspect tax records, loan payoffs, outstanding mortgages, maintenance fees, inspections, and insurance policies to ensure the turnover is clean and secure.
Title Insurance Policy
Issuing title insurance is one of the services provided by a title company. This protects the buyer and their lender from costs and losses related to the title of the property.
To secure financing, this is often required by mortgage lenders before proceeding with the loan and, consequently, the sale.
Risks Without Title Insurance
Title insurance policies aim to protect you from accidental mistakes in official documents, malicious tempering, fraud, accusations or impositions of tax liens, and other changes.
Without title insurance, a buyer is exposed to financial and personal risks if a defect needs to be corrected. For example, if there are unpaid property taxes from the previous owner, the buyer will have to pay these taxes alone without title insurance.
Of course, this risk is not the same for every property. If a house has passed through numerous owners or the history is unclear, the risks are higher. Moreover, if you’re planning to use the property as an investment and have plans to resell, ensuring the title is clean is a necessary asset.
Types of Title Insurance
There are two types of title insurance – the lender’s policy and the owner’s policy.
The lender’s policy is issued to protect the lender who is involved in the transaction. Their stake in the property ends when the mortgage is fully paid since, in that case, the buyer no longer needs financial backing.
The owner’s title insurance protects the owner from the risks and defects that may come with the title. The benefits of this end when the heirs of the insurance holder no longer have an interest or stake in the property.
A title search is a process of examining public records to confirm the seller’s claims on legal ownership. Usually, a title search uncovers erroneous surveys and unresolved building code violations. A title company will cover the process and document what the seller needs to deliver before releasing escrow and finalizing the sale.
A clear title is non-negotiable; therefore, due diligence should be conducted to ensure this.
Title and Escrow: Which One Should You Use?
Now that we have established the difference between a title company vs escrow, it’s time for you to choose the best for your transaction’s needs.
Benefits of Using Escrow Companies
- Protection of legal and financial interests as the earnest money is secured until the fulfillment of the parties’ arrangements.
- Extensive knowledge of real estate transactions against fraud and enforcing mechanisms to prevent buyers and sellers from bypassing the arrangements.
- Not all states recognize title companies and still require a licensed attorney to administer the closings and gather documents. Whenever this applies, an escrow service is the cheaper option to aid your real estate attorney’s services.
Benefits of Using Title Companies
- They have established thorough methods for conducting a title search that will be an inconvenience if the buyer does it alone.
- They offer affordable title insurance as a result of their established business that comes with their title search services.
- They can offer an all-in-one service. They can conduct the title search, issue title insurance, manage the closing of the transaction, and handle escrow funds. On the other hand, an escrow company cannot administer real estate closings or provide title insurance.
Your needs may differ from one transaction to another, and the costs for extensive services may not be worth it for some. It is a best practice to check the purpose of your purchase, the history of the property, and the level of risk each buyer and seller uniquely has.
In the end, both a title company and an escrow company will help sellers turn the key over to the buyer in a secure and convenient deal.
Josh is a financial expert with 15+ years on Wall Street as a senior market strategist and trader. Josh graduated from Cornell University with a business degree in Applied Economics and has held numerous U.S. and European securities and brokerage licenses including FINRA Series 3, 7, 24, & 55. In addition to running an investment and trading firm, Josh is the founder and CEO of Top Dollar, where he teaches others how to build 6-figure passive income with smart money strategies that he uses himself.