Escrow is an agreement between two parties, usually in the form of a bond, deed and documents, which are kept in trust by a third party until a particular set of conditions are met.
The term hails from the Old French word ‘escroue’ meaning a scrap of paper or scroll of parchment.
In real estate, that third party is known as an escrow agent.
The conditions that need to be met are generally things like a property inspection, building appraisal and finance approval.
When both parties are satisfied, the money is released and the sale of the property is completed.
Escrow isn’t only used to facilitate the sale of a property.
It is also used to as a middle man between a lender and borrower.
Escrow in California
California differs somewhat from many other US states because it is an ‘escrow state’, rather than an attorney state or title-closing state.
It is not a legal requirement to use escrow but is typically done so as a vehicle to ensure neutrality, facilitate title insurance, risk management and lender requirements.
Escrow agents must be licensed and be independent of buyer and seller.
These agents draw up binding contracts which must be honored with cash or wire transfers before disbursement.
Cashier’s cheques may be permitted but personal cheques are not.
The deal does not officially close until it is recorded by the county.
How the escrow process works, step by step
Open escrow – The buyer’s agent opens escrow after a purchase agreement is signed with a seller. The buyer then deposits earnest money of between 1-3% of the purchase price into the escrow account.
Escrow instructions – Both parties sign instructions detailing the terms, conditions and obligations.
Title search & insurance – Escrow orders a title search to ensure the buyer is getting clear ownership of the property. Title insurance policies are then prepared to protect the buyer against a range of unforeseen circumstances.
Disclosures & contingencies – The seller provides required disclosures such as the Transfer Disclosure Statement and Natural Hazard Disclosure. The buyer conducts their inspections and due diligence and has the right to remove contingencies such as finance, appraisal and inspection.
Loan processing – The buyer’s lender sends the loan documents to escrow which prepares a Closing Disclosure (CD) with final numbers for the buyer to sign.
Funding & payoffs – The buyer wires their downpayment to escrow while their lender wires the balance of funds. That money is then used to pay off the seller’s mortgage, any liens, commissions, fees and prorated taxes and insurance.
Final review – Escrow confirms all conditions are met with documents signed, loan funding received, insurance met and a clear title.
Recording – Escrow sends the deed to the County Recorder. Once recorded, the property legally transfers to the buyer.
Disbursement & closing – Escrow disburses the balance of funds to the seller, the keys are handed to the buyer and escrow is closed.
Escrow costs and timelines in California
In California, escrow normally costs between 0.2-0.5% of the value of a property.
For a $1,000,000 property, that cost equates to between $2000-$5000.
The length of a standard escrow is between 30-45 days but it can take longer for complex deals.
Delays are usually due to lengthy loan approvals, appraisals, title issues or incomplete disclosures.
In the case of cash payments, it may take as little as 7-10 days if the title is clear and disclosures are ready.
Escrow and property flippers
The most successful property flippers in California use hard money for its accessibility and flexibility.
Escrow works for flippers just like any transaction between a seller and buyer.
It holds the buyer’s purchase funds, while paying off the seller’s hard money loan, interest and agent’s fees before wiring them the profit.
It also ensures the buyer receives clear title with no tax liens, mechanics liens or seller encumbrances.
Sometimes, flippers will use ‘double escrow’ by trying to buy and sell properties simultaneously.
In California, this requires two separate escrows whereby the second one cannot close until the first has been recorded.
Escrow and hard money lenders
Hard money lenders structure their loans differently from traditional lenders but escrow is also the third party in the deal.
When a flipper buys a property, their hard money lender wires the funds to escrow.
The funds are only released after loan documents are signed and recorded.
Escrow receives and manages:
- Deed of Trust which is recorded against the property to give the lender security
- Promissory note which is the borrower’s promise of repayment
- A personal guarantee may at times accompany the above
Before releasing funds, lenders may require escrow to collect prepaid interest, loan origination fees and hazard insurance.
Escrow also ensures the lender is in the ‘first lien position’, meaning there are no prior liens on the property.
Upon sale of the property, escrow automatically pays off the hard money lender from the buyer’s funds, as well as any prepayments, late fees or extensions, leaving the flipper with the profits.
Why escrow is crucial for flippers using hard money
Escrow works like an insurance policy for both flipper and hard money lender by protecting the interests of both parties.
It does this by offering:
Speed – ensuring fast closing for hard money lenders and borrowers by coordinating quick title searches and priority recordings to facilitate same-day funding.
Transparency – offering the lender security and the flipper confidence about when their funds will be released.
Lien protection – avoiding delays and complications due to unpaid contractor liens.
Exit strategy – guaranteeing the lender is paid, the title cleared and profits swiftly released to the flipper.
How a flipper might use a hard money loan with escrow
Sammie has been flipping houses for 12 months and finds an ideal distressed house in Chino with an asking price of $600,000.
She has a downpayment of $120,000 and applies for a hard money loan for the balance.
The lender wires that balance of $480,000 into escrow while Sammie sends her downpayment and closing costs.
Escrow records the deed and deed of trust, pays the seller their $600,000 and closes.
Five months later, Sammie sells the property to Liam for $800,000.
Liam’s funds go into escrow which pays off Sammie’s hard money lender ($480k as well as accrued interest and points), commission and any mechanics’ liens.
Escrow then wires Sammie the balance, which amounts to a nice profit of $105,000.
Other key definitions related to escrow
Deed – a legal document that transfers ownership of a property from one party to another.
Deed of Trust – a legal document used to secure a loan on a property.
Earnest money – a deposit paid to confirm a contract.
Escrow agent – a third party hired to handle escrow on behalf of the buyer and seller or borrower and lender.
Title insurance – protects property owners and lenders against losses from defects in the property’s title including fraud, unreleased liens, improper deeds, boundary disputes, unknown heirs claiming ownership and errors in recording.
Inspection contingencies – a clause added to a purchase agreement making the buyer’s obligation conditional, such as a structural or plumbing inspection. Standard California purchase agreements come with a 17-day Inspection Contingency Period although it is negotiable.
Financing contingencies – a clause added to a purchase agreement making the buyer’s obligation conditional on obtaining finance with acceptable terms. Standard California purchase agreements come with a 21-day default period but this is also negotiable.
Mechanic’s lien – a legal tool in lieu of funds owed to contractors, laborers or material suppliers which prevent the sale of the property until the debt is cleared.
Escrow instructions – specific directions given to the agent by the buyer, seller or lender that detail how funds, documents or conditions of the contract must be handled.
Special escrow – an escrow account with particular clauses or restrictions tailored to a specific risk, often implemented to cover repairs, loan reserves, disputes or regulatory compliance.
Get funding and advice today
There’s a lot more to flipping houses than simply renovating bathrooms and building ADUs.
There is so much to consider and understand about every purchase, every sale and every loan.
That’s why it is important to have an experienced finance mentor in your corner, providing both funding and guidance.
And if that’s what you seek, you need look no further than Equidy.
Equidy has had an intimate and personal history with all aspects of real estate and property development in California for more than 40 years.
Equidy is a hard money lender, offering fast funding and flexible terms to flippers and developers of all kinds.
They stand by their core belief that anything is possible and they are determined to prove it every single day.
Even in challenging economic times, they love to reward entrepreneurship and strive to see their clients realize their wealth creation dreams.
Equidy enjoys long and established relationships with serious investors, sellers and real estate professionals while leveraging their reputation and trust, using clear communication to minimize the risk to all parties.
Contact Equidy today to book your free strategy call.
