Question 1

What is escrow?

Accepted Answer

At its essence, escrow is the process whereby parties to the transfer or financing of real estate deposit documents, funds, or other things of value with a neutral and disinterested third party (the escrow agent), which are held in trust until a specific event or condition takes place according to specific, mutual written instructions from the parties. Escrow is essentially a clearinghouse for the receipt, exchange, and distribution of the items needed to transfer or finance real estate.

When the event occurs or the condition is satisfied, a distribution or transfer takes place. When all of the elements necessary to consummate the real estate transaction have occurred, the escrow is “closed”.

Section 17003(a) of the California Financial Code defines escrow as "…any transaction in which one person, for the purpose of effecting the sale, transfer, encumbering, or leasing of real or personal property to another person, delivers any written instrument, money, evidence of title to real or personal property, or other thing of value to a third person to be held by that third person until the happening of a specified event or the performance of a prescribed condition, when it is then to be delivered by that third person to a grantee, grantor, promisee, promisor, obligee, obligor, bailee, bailor, or any agent or employee of any of the latter”.

For your reference, the California Escrow Law (“Escrow Law”) is contained in Division 6 of the Financial Code, commencing with Section 17000, and Subchapter 9, Title 10 of the California Code of Regulations, commencing with Section 1700. In addition to its elusive nature, escrow transactions can be unpredictable and stressful for the participants. It is safe to say that you cannot fully understand and appreciate how escrow works and what to expect until you have personally been involved in an escrow transaction. A successful escrow is usually the product of an experienced team of real estate, title, and escrow professionals working together to guide you through this short lived, yet very important, arrangement.

Question 2

Why is escrow important?

Accepted Answer

Escrow is a service that protects the public and minimizes the potential risk involved in any real estate transaction. With an experienced neutral third party in possession of the legal documents and funds, which party is obligated to safeguard the instruments and funds, buyers and sellers, as well as lenders and borrowers, can safely interact with one another and be assured that no legal documents will be recorded, and no funds will be released, until all of the conditions of the real estate contract or agreement between the parties have been completed.

Question 3

Who can provide escrow services in California?

Accepted Answer

In order to perform escrow services in California, the Escrow Law states that an escrow must be a corporation, in the business of receiving escrows for deposit or delivery, and be licensed by the California Corporations Commissioner.

However, there are exemptions provided in the Escrow Law which allow other entities and persons not licensed by the Department of Business Oversight (“DBO”) to perform escrow services. Such escrow agents are exempt from the licensing requirements of the Escrow Law and include the following: 1) any bank, trust company, building and loan or savings, or insurance company under any law of this State or the United States; 2) any California licensed attorney who has a bona fide client relationship with a principal in a real estate or personal property transaction and who is not actively engaged in the business of escrow; 3) any title company licensed by the California Insurance Commissioner; and 4) any real estate broker licensed by the California Department of Real Estate while performing acts in the course of or incidental to a real estate transaction in which the broker is an agent or a party to the transaction and in which the broker is performing an act for which a real estate license is required.

The Escrow Law also states that with respect to 2) and 4) above, the exemption is personal to the licensed persons listed (attorneys and real estate brokers, respectively), and those persons shall not delegate any duties other than duties performed under the direct supervision of those persons. Also, the exemption is not available for any arrangement entered into for the purpose of performing escrows for more than one business. In the terminology of the escrow industry, all escrow agents performing escrow services in California are either “licensed” or “controlled” escrow companies. A "licensed" escrow company, which is also known as an “independent” escrow company, is licensed by the DBO.

This license can only be obtained after the escrow company has met and satisfied all of the licensing requirements set forth by the Escrow Law, which are enforced by the DBO. A "controlled" escrow, which may be known as a “nonindependent” escrow, is not licensed by the DBO. A controlled escrow could be owned and operated by any of the persons or entities mentioned above, such as a real estate broker or title insurance company.

The licensing and regulation of controlled escrows depends on the jurisdiction of the licensing and regulatory authority that they are 6     operating under. Therefore, the licensing requirements, laws, and regulations that they are subject to vary widely

Question 4

Who chooses the escrow holder?

Accepted Answer

The choice of escrow is normally agreed upon by the principals to a real estate transaction and reflected in writing in the purchase contract. A seller may elect to choose "ABC Company" and the buyer may choose "DEF Company," but both parties must ultimately agree, like they must on all terms and conditions of a sale. If a real estate broker is involved, it may be a common practice for the broker to recommend an escrow company, especially if the broker continually does business with a particular escrow officer or company. With a refinance transaction, if you are a borrower refinancing your property and working with a mortgage broker, it is usually the broker who will select and/or recommend an escrow provider for you.

However, while a real estate broker may suggest an escrow holder, he or she may not designate an escrow holder as a condition precedent to a transaction. It is also important to note that there are laws which prohibit the payment of referral fees, rebates, and/or kickbacks between escrow, title, and real estate companies, for the referral of business.

Except for normal compensation between an escrow company and its employees, Section 17420 of the Financial Code provides that for those under the jurisdiction of the Escrow Law, it shall be unlawful for any person who pays over to any other person any commission, fee, or other consideration for referring, soliciting, handling, or servicing escrow customers or accounts. Basically, escrow holders are prohibited by law from the giving of any consideration to a party as an inducement for receiving an escrow.

There are comparable laws that prohibit referrals fees and rebates that govern real estate brokers and title insurance companies as well. Please remember that when it comes down to the selection of the escrow holder, you as the consumer always have the right to choose an escrow that is professional, competent, reasonably priced, and which will fulfill your transactional needs.

Question 5

When does escrow typically open and how does it work?

Accepted Answer

In the typical escrow, the principals to the real estate transaction that requires an escrow (borrower, lender, buyer and/or seller) cause escrow instructions to be created, signed, and delivered to the escrow officer. In the case of a real estate sale/purchase, escrow usually opens when a fully executed purchase agreement has been delivered to an escrow holder.

The good faith deposit or initial down payment may or may not be deposited at the same time. The delivery of the signed purchase agreement and/or accompanying deposit to an escrow company is usually facilitated by the listing or selling broker involved. Upon receipt of a fully executed purchase contract and/or good faith deposit, the escrow officer will normally assign the transaction an escrow number. When calling your escrow officer with questions or concerns, it is helpful to have this escrow number handy because this will allow the escrow officer to locate your file more easily. The applicable broker will typically provide the escrow officer with important information regarding the transaction, such as the names and contact information for the principals, lending and title information, selection of service providers, and other necessary details.

After escrow opens, the escrow officer will order a real property title search with the title company designated by the parties, if this has not already been done by the listing broker, and prepare escrow instructions. These instructions are normally pre-approved by the brokers involved in the transaction. Once they are deemed to be error free and finalized, the instructions are sent to the parties for signature.

These instructions essentially tell the escrow officer what to do and when to do it, and basically give the escrow officer the authority to act. It is worth pointing out that there are some aspects of a real estate transaction that are not part of the escrow. For instance, the purchase agreement contains several items that are not handled by escrow holders, such as buyer and seller agreements regarding property fixtures, personal property, removal of contingencies, liquidated damages, arbitration and mediation.

It is important to remember that if you have specific questions about the purchase agreement, you should contact your licensed real estate broker or licensed attorney.

Basically, the escrow officer can only process the escrow in accordance with the escrow instructions. Therefore, without signed instructions, the escrow officer cannot act or proceed. The escrow officer will then perform those functions that they were authorized to do in writing by the mutual agreement of the parties to a transaction, unless an instruction(s) is unlawful and/or against the policy of the escrow holder.

The required conditions, processing, and facilitation of the escrow may differ depending on the type of transaction and property involved. However, regardless of the type of escrow being performed, it is only when all of the conditions required in the escrow instructions have been satisfied that the escrow will be complete.

At the close of escrow, the escrow officer will release funds and documents in accordance with the escrow instructions, pay all bills as authorized, and prepare and deliver a final closing statement to the parties.

Question 6

Exactly what are escrow instructions?

Accepted Answer

Escrow Instructions, which are prepared by the escrow officer, identify all of the terms and conditions of the escrow, as well as the escrow holder's general provisions and legal responsibilities and limitations. They are usually detailed in nature and prepare the escrow officer for every situation.

The instructions typically identify the escrow holder's contact information and escrow number, license number, important dates including the date escrow opened, as well as the date it is scheduled to close, the names of the parties to the escrow, property address and legal description, purchase price and terms, how buyer's title is to vest, proration adjustments, matters of record to which buyer is subject when he or she acquires title, disbursements to be made, fees and charges and who is responsible for payment, documents to be signed, delivered, and recorded, and the process and roadmap that must be followed by the escrow holder in handling the escrow. Additionally, escrow instructions usually reflect the agreements made between the parties with respect to the escrow and the duties of the escrow officer.

These duties typically include, but are not limited to, ordering the title search, requesting payoff demands and beneficiary statements, facilitating the receipt and approval of reports, making prorations and adjustments, paying bills, obtaining the buyer’s or borrower's approval and signature on loan documents, requesting closing funds and authorizing recording, closing the escrow after confirmation of recording, preparing final closing statements, disbursing funds, and delivering documents to the appropriate parties. In sum, escrow instructions indicate all of the specific steps to be completed and conditions that must be satisfied before the escrow is complete.

Because an escrow holder may only act upon specific written and mutual instructions of the principals, the escrow instructions must be clear in content, accurately reflect the intention of the parties and the duties of the escrow holder, and avoid ambiguity. When fully executed by all parties, the instructions become an enforceable contract and the escrow becomes effective.

As a consumer, it is important for you to know that an escrow officer may not solicit or accept an escrow instruction, or supplemental escrow instruction, containing any blank that can or is to be filled in after signing or initialing of such escrow instruction.

An escrow officer is also prohibited from allowing any person to make any additions, deletions, or alterations to an escrow instruction unless the changes are signed or initialed by all persons who had signed or initialed the original escrow instruction prior to the modification.

Question 7

What types of transactions go through escrow?

Accepted Answer

All sorts of transactions use escrows to facilitate the transfer, lease, or financing of real or personal property. Escrows are most commonly used when – real property is bought, sold, or refinanced, but they are also utilized for the purchase or sale of business opportunities or mobile homes.

Bulk sales, stock transfers, and holding escrows are less well known, but are other types of transactions handled by an escrow company. Escrows in non-real estate transactions (e.g., those for personal property) are beyond the scope of this publication.

Question 8

Who pays for the escrow fee?

Accepted Answer

In a real estate transaction, it is customary that the escrow fee be split between the buyer and seller, although, as noted above, the northern and southern regions of California have different customs. Ultimately, however, the buyer and seller may negotiate and agree to any arrangement. This agreement should be reflected in writing in the purchase contract.

With a real property refinance, the borrower is usually responsible for the escrow fee. In the event that the escrow officer has discounted, waived, or reduced the escrow fee of one party or principal due to the prospect of repeat business, this could be a violation of 17420 of the Escrow Law, as briefly discussed above, as well as a federal Real Estate Settlement Procedures Act (“RESPA”) violation. However, the parties and principals to an escrow may freely negotiate escrow fees with escrow agents as long as the selection of the escrow (or the fee structure) was not induced by the offer of a reduced or discounted escrow fee. If an escrow holder does depart from their normal fee schedule as a result of negotiation between the escrow holder and principal, as long as all parties to the escrow are aware of the fee being charged and said fees are clearly disclosed in the escrow instructions, there is no apparent violation of the law.

For more information on this topic, you can take a look at DBO's website and/or review an excellent escrow bulletin issued by the DBO which discusses payment for escrow fees. The citation for the bulletin is:

http://www.dbo.ca.gov/Archives/Laws/Escrow/pdf/EscrowBulletin_0107.pdf.

Question 9

What are closing costs?

Accepted Answer

Closing costs refer to and include a variety of costs incurred by either a buyer or seller in excess of the selling price of a property. They are largely determined by the terms and conditions of the contract, the type of transaction, and where the property is located. Having said that, there are certain fees and charges that are expected regardless of the above factors. For example, in a real estate transaction, it is customary that there would be fees in connection with obtaining a new loan, paying off an old loan, fees for escrow and title, recording documents, documentary transfer taxes, real estate commissions, prepaid property taxes, home warranties, and insurance premiums. If applicable, there may also be several recurring costs or fees, or prepaid items that are prorated through escrow. Again, all of these fees and charges will be reflected on the escrow's closing statement.4

Question 10

What are prorations?

Accepted Answer

In a real estate transaction, there are usually expenses and payments that must be “prorated” (or properly distributed or divided proportionately) so that the parties are equitably responsible for amounts owed during their respective ownership of the property. For example, the seller is the beneficial owner of the property until the close of escrow, when ownership and possession is delivered to the buyer. Naturally, there are some items or expenses that have been prepaid by the seller. In order to equitably reconcile these prepaid items or recurring costs in connection with the property, the escrow holder may be instructed by the parties to prorate those expenses. Examples of these items/expenses include property taxes, rental income, security deposits, property insurance, interest, and homeowner association dues. The items are usually prorated using the date of the close of escrow and some other "paid to" date.

For example, if a seller paid $300 in homeowner association dues for the month of May and escrow were scheduled to close on May 15th, the escrow officer, if instructed, would likely prorate said dues from the close of escrow to June 1st. This proration would result in a credit (reimbursement) to the seller for the period of time he or she is no longer the owner of the property, and a debit to the buyer for the period of time that he or she has been the owner of the property and responsible for the dues. If you are a buyer or borrower and obtaining a loan, you will most likely pay a proration of mortgage interest in connection with, and as a requirement of, your new loan. If you have questions regarding the prorations of items on your estimated or final closing statement, your escrow officer will be able to help you.

________________________
4 It should also be noted that whenever California real estate is sold or transferred, there are specific State and federal real estate tax withholding requirements that may apply pursuant to the California Revenue and Taxation Code and/or the Internal Revenue Code, respectively. For more information, you should visit www.ftb.ca.gov and www.irs.gov.

Question 11

What is a closing statement?

Accepted Answer

A closing statement is an accounting or itemized list of all of the charges and credits in connection with your escrow account which is prepared by the escrow officer. In addition to closing costs, the closing statement will reflect the purchase price and financial terms, funds deposited, debits or credits, payments to third parties, and payoffs of existing loans and/or liens.

The closing statement will indicate how much money you may need to bring into the escrow or how much money you are to receive at the close of escrow. When buying or refinancing a residential property (1-4 dwelling units), the Department of Housing and Urban Development (“HUD”) requires both a Good Faith Estimate and a final HUD-1 statement of closing costs to be provided to the buyer/borrower at specific times in the transaction.

These requirements are part of RESPA. Please take a look at www.hud.gov if you want more information.

Question 12

In a typical real estate transaction, what are the buyer's and seller's responsibilities?

Accepted Answer

Buyers and sellers have different responsibilities in an escrow transaction. For buyers, if the transaction is contingent upon a loan, they must arrange the loan directly with a lender of their choice or choose to work with a mortgage broker to arrange the necessary loan for them.

A buyer or his or her real estate agent or broker must provide the escrow officer with the contact information of the mortgage broker and/or lender because part of the escrow officer's duties is to follow-up on the progress, approval, processing, and funding of the buyer's loan. Also, when a lender is involved, a buyer will have to obtain a new hazard insurance policy on the property that is acceptable to the lender. This information will also be requested by the escrow officer and the buyer will be expected to provide it to the escrow. Lastly, buyers are responsible for instructing the escrow officer about the way in which they will take title to the property.

Title vesting options and decisions should be taken seriously, fully researched by the buyer, and a licensed attorney and/or tax professional should be consulted if questions arise. Sellers must provide escrow officers with different types of information. If the property is mortgaged, the seller will have to provide the escrow officer with the name of their mortgage lender, loan number, and contact information.

Additionally, sellers have to provide information related to their property taxes, homeowner's insurance, rental data in the case of investment property, and homeowner association information in the event of a condominium. If title to the property is in trust, the seller may have to provide a copy of the trust and/or certificate of trust to both the escrow and title company. The requirements placed and imposed on the parties to an escrow vary depending on the nature of the transaction and may change due to unexpected circumstances.

In an effort to fully understand what will or may be expected of you, it is important to communicate with your escrow officer about these items in advance.

Question 13

How should I take title to my property?

Accepted Answer

As noted above, one of the decisions you will have to make when you are purchasing a property will be how you would like to hold title to the property. There are several different title vesting options (joint tenancy, community property, community property with right of survivorship) in California, and each one has different tax, legal, and/or estate consequences. It is wise not to rush through this part of the escrow paperwork. Rather, you should do your homework and consult a licensed attorney or tax professional if you have questions.

Question 14

What documents need to be acknowledged in front of a notary?

Accepted Answer

The answer is that a notary (which some may refer to as a notary public) must acknowledge any real estate or related document that will be recorded in the office of the County Recorder where the real estate transaction will occur.

Notaries are individuals authorized by the State to certify documents and attest to the authenticity of signatures, among other things. If you are a buyer obtaining financing on a real estate purchase or a borrower refinancing your property, there are several documents included in the loan packet, particularly the deed of trust, that require a notarial acknowledgment.

Typically, the lender will send your loan documents to escrow, and the escrow officer will coordinate the signing of your loan documents with a notary. If any party to an escrow is in a trust, or taking title in trust, a certification of trust -- which is a notarized document -- is often required by the title company. If you are a seller, you will need to sign a grant deed and have it acknowledged by a notary.

If any party is granting or conveying an interest or quitclaiming to another, he or she will need to have their signature notarized by a notary. A California notary must be registered with the Secretary of State, and will be subject to several requirements before being commissioned to perform notarial duties.

Please see the California Secretary of State's website, www.sos.ca.gov, for more information.

Question 15

What if I have to remit (pay or add more) funds at closing?

Accepted Answer

If you are required to deposit funds into escrow at the close of a transaction, you must keep in mind a few important things. First, you will need to provide "good" funds or certified funds to escrow in the form required by the escrow holder. The closing of an escrow can actually be delayed if funds are not deemed to be "good" funds. For example, if you deposit an out of state check or personal check, it could take several days for that check to clear. Most escrow companies will require either a cashier's check or wire transfer. Second, in order to close on time, these funds will be due in escrow by a certain time and date.

The escrow holder’s policy on closing funds is often found in the escrow instructions. However, it is always a good idea to be in communication with your escrow officer about the necessity of depositing funds into escrow at the closing. Be sure to confirm the escrow company's policy as well as make the necessary arrangement to guarantee that your funds will be delivered correctly and “cleared” on time.

It is important to know that escrow officers only authorize recording of the closing documents when all funds on deposit have been collected and cleared. The so-called “Good Funds Law” in California, found in Section 12413.1 of the California Insurance Code, requires that a controlled escrow company and a title company must have in possession sufficient good funds in order to close a real estate transaction.

Question 16

What do the terms "funding" and "recording" mean?

Accepted Answer

The term "funding" usually refers to when your lender actually “funds” (provides the money to finance) your loan. The funding of a loan will occur only after all of the lender's conditions have been satisfied and escrow has requested funding from your lender. The escrow officer will work with the lender, as well as the mortgage broker if there is one, to ensure that the loan funds in accordance with the lender instructions and the contractual timeline of the escrow. Please note that even when all of the lender's conditions and requirements have been satisfied, the escrow officer will not authorize funding until all of the required conditions of the escrow have been met.

The term "recording" signifies when the title company has released all of the documents which must be recorded to the County where the property is located and those documents have been recorded (usually by the office of the County Recorder). Unless there are unexpected problems or delays either in escrow or title or both, it is only after the escrow officer determines that all of the conditions of the escrow have been met that they in turn authorize title to record the documents. "Recording" is also sometimes used interchangeably with "closing."

It is typical that when a loan funds, the recording will take place the following business day. However, there are Counties that perform same day recordings, where the recording takes place on the same day that the loan funds.

Question 17

How long does an escrow take to complete?

Accepted Answer

The length or term of an escrow is largely determined by the mutual agreement of the parties to the escrow. The number of days it will take to complete the escrow and/or the target closing date are indicated in the purchase contract and escrow instructions.

Sometimes, the closing of an escrow can be delayed by the time it takes to approve and underwrite the loan if a lender is involved and new financing is being obtained by a buyer or borrower. Also, an escrow may not close on time as a result of unexpected circumstances, documents that have not been signed, or disputes between the parties.

Question 18

What happens when escrow closes?

Accepted Answer

When an escrow has “closed”, this means that all of the conditions of the escrow have been met, the loan has funded in the case of transactions involving new financing, documents have been recorded, and the property and funds have legally changed hands.

At closing, your escrow officer will be responsible for several things. Specifically, the escrow officer will be preparing your final closing statement which is essentially an itemized accounting of the escrow which reflects all of the non-recurring and recurring closing costs, credits and debits, and prorations.

The final closing statement will represent all of the financial terms of the transaction. If funds are due you at the close of escrow, the escrow officer will be responsible for disbursing those funds. The escrow officer will also be responsible for the disbursement of commissions to real estate brokers and mortgage brokers, as well as payments due to homeowner associations, termite companies, insurance companies, notaries, natural hazard disclosure companies, and other third party and service providers.

Question 19

What happens when a transaction fails to close and the escrow cancels?

Accepted Answer

Many escrow instructions provide for cancellation of escrow in the event of a default. Where a transaction fails to close, the parties will need to execute a cancellation agreement. If the parties are able to come to a mutual agreement to cancel, it is likely that the parties will execute a “cancellation of contract” completed by a real estate broker.

Also, most escrow companies will prepare and require their own mutual cancellation instructions to be executed, and this is especially true in cases where the escrow holds funds on deposit. Before the escrow officer can release any funds, the parties must agree to the disposition of the funds in writing.

This instruction will include the payment of any applicable fees or charges incurred by the escrow holder or other costs indicated in the escrow instructions. In some cases, the escrow officer may charge an escrow cancellation fee, if such a fee had been disclosed and agreed upon by all parities in the escrow instructions. If there is no agreement between the parties as to the disposition of funds on deposit, the escrow officer will not release any funds until an agreement is reached in writing.

In cases where the parties cannot agree to cancellation or to related terms, the disposition of funds, and/or are unable to resolve a dispute, the escrow holder may have to file an interpleader action in court and a judge will have to decide which parties are entitled to what documents and/or funds.