A Primer on Escrowed Funds

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Upon signing the agreement of sale in most residential real estate transactions, the buyer pays an “earnest money deposit”, which signifies his intention to purchase the property. Typically, the earnest money deposit is held in the escrow account of the listing broker (who represents the seller) and is applied toward the buyer’s down payment and closing costs at settlement.

Know Your Rights!

The parties to any residential transaction, including the brokers, should be aware of the rules and responsibilities that surround any deposit monies that are being held in escrow—the laws vary from state to state, so it is imperative that you familiarize yourself with the laws of the state that govern your particular transaction. Using the Commonwealth of Pennsylvania as an example, a broker receiving money that belongs to another must deposit that money in an escrow account by the end of the next business day following its receipt. This duty can’t be waived and it can’t be altered by agreement between the buyer and seller or by the brokers to the transaction. Although the law is clear as to the course of action a broker must take upon receiving monies belonging to a third party, the law does not dictate who must hold the funds in escrow. Therefore, it is up to the parties to come to an agreement on who will hold the escrow; some examples include the broker for the seller, broker for the buyer, attorney for the buyer, attorney for the seller, builder, or bank. It should be stated either in the agreement of sale or by way of an addendum who will hold the deposit monies. In Pennsylvania, the standard Agreement of Sale contains a default provision, which states that unless agreed upon otherwise the listing broker holds the deposit monies until closing.

The buyer, seller and brokers should be aware of the fact that many third parties, such as a title company or bank, will require the execution of an “Escrow Agreement” as a condition of holding funds. The Escrow Agreement usually states the amount of money being held, the terms and conditions that must be met prior to the release of the funds, and a disclaimer of any liability in the event that the escrow holder releases funds upon a good faith reliance on documentation submitted by an authorized party. Further, both buyer and seller need to understand that just because the deal falls through doesn’t necessarily mean that the deposit money goes to them.

Since the deposit monies are being held in trust, both buyer and seller must agree as to the disposition of the funds before the escrow holder will release it. In most states, the escrow holder can only release funds if there is a written release executed by buyer and seller, if a settlement takes place, or by court order. Therefore, if a dispute has arisen between buyer and seller, the parties would be wise to work out some sort of agreement with respect to the escrowed funds otherwise the monies will remain tied up.

Whether you are the buyer, seller or broker involved in a residential transaction, you need to know what will happen with any deposit monies, so here’s a quick review:

1. Know the laws in your state dealing with escrowed funds- Who is authorized to hold funds in escrow? What are the escrow holder’s responsibilities? If there is a dispute between buyer and seller, what happens to the funds?
2. Identify the escrow holder in your agreement of sale or by way of addendum
3. If there is an escrow agreement, it should be reviewed by all parties. If you don’t agree to its terms, don’t sign it!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.