Home buying has a bunch of small and not so small expenses in addition to your down payment. If you’re getting serious about making an offer on your dream home, you need to be putting some money aside to cover some or all of these expenses early in the process.
An escrow account is a place to hold money that will cover expenses related to your home purchase, and also serve as a safety net for the seller in case you bail on the purchase last minute.
The first thing you’ll put in the escrow account is “earnest money.” This will go to the seller if you back out, to help defray costs due to missing out on prime selling season and/or having to go to the trouble of relisting and showing their home all over again to attract another buyer.
Your offer should have contingencies written in to protect you as well, so you can get that earnest money back if the appraisal comes in lower than expected or the home inspection reveals the home needs more work than you’re willing to put in.
You may also be able to include a financing contingency which allows you to receive a refund of your earnest money if you run into an unexpected problem with your loan approval.
Escrows / Prepaid Items
You might also transfer funds for things like appraisals and inspections and title searches into the escrow account depending on your lender and the state you live in. The escrow account can pay out for these expenses from your escrows as the home sale progresses.
Prepaids are other expenses that you will pay for at closing, to cover upcoming expenses. Your lender might require you to cover monthly or annual fees in advance for taxes, hazard insurance, private mortgage insurance, or special assessments.
You may also be required to have two months of payments prepaid into the escrow account at closing, so your lender can continue to pay premiums for various expenses as they come due in the years ahead. This protects the lender and provides a buffer in case of unexpected events or delays.
Cash Needed to Close
Your escrow deposit may total anywhere from 2-4% of your total purchase price, and will vary based on the date you close and the date the next round of property taxes are due. Every state is different, and you and the seller may be able to split taxes for the month the home sale closes. Ask your lender to get a clear idea of the property taxes you can expect to pay based on your closing date (you will get the exact amount in the closing disclosure 3 days before closing.)
Finally, find out if you prepay your homeowners insurance and the lender handles disbursement to the insurer, or if you are responsible for handling this item yourself. Many lenders like to have control of this step so they know the insurance is always current.
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