Escrow is a neutral depository arrangement in which a disinterested third party (the escrow holder) holds funds, documents, and instructions from both buyer and seller, and carries out their mutual instructions upon satisfaction of agreed-upon conditions. Escrow is the mechanism that allows a real estate sale to close safely — neither party releases their consideration until all conditions are met.
In California, the escrow holder is an agent of both parties simultaneously — a limited dual agent for the exclusive purpose of carrying out the escrow instructions. The escrow holder cannot favor either party; their duty is to follow the written instructions they have received.
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California law regulates who may conduct escrows:
Regional customs:
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Step 1: Opening Escrow After the buyer and seller execute the purchase agreement (RPA), the listing agent or cooperating agent opens an escrow file. The escrow company receives the executed purchase agreement and prepares escrow instructions based on the terms.
Step 2: Depositing Earnest Money The buyer deposits the initial earnest money (good faith deposit) into escrow. The funds are held in the escrow company's trust account. Per the CA RPA, this is typically due within 3 business days of acceptance.
Step 3: Preliminary Title Report and Review The title company issues a preliminary title report within the first week or two. All parties review the prelim for unexpected liens, easements, or title issues.
Step 4: Loan Processing and Approval The buyer's lender processes the loan application. The lender orders an appraisal. When the loan is approved, the lender sends loan documents to escrow.
Step 5: Inspections and Contingency Removal The buyer conducts inspections. Disclosure documents (TDS, NHD, SPQ) are delivered and reviewed. The buyer removes contingencies (loan, appraisal, inspection) in writing using the Contingency Removal form.
Step 6: Signing Documents The buyer signs loan documents (at the title company or with a mobile notary). The seller signs the grant deed and transfer tax documents.
Step 7: Funding and Recording The lender wires funds to escrow. The escrow holder:
Step 8: Close of Escrow (COE) When all documents are recorded and funds are disbursed, escrow is considered "closed." The buyer receives the keys.
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Prorations divide ongoing income or expenses (property taxes, HOA dues, rents, utilities) between buyer and seller as of the close of escrow date.
Convention: The closing day typically belongs to the buyer. Seller owes for days before closing; buyer owes for closing day and after.
Property tax example:
Rent proration example:
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Quiz Questions:
Q1. In Southern California, who typically handles escrow on a residential sale?
A) The county recorder's office B) An independent licensed escrow company (most common in SoCal) or a title company C) The buyer's real estate attorney D) The buyer's lender
Answer: B — Southern California traditionally uses independent escrow companies (not affiliated with title companies) as escrow holders. Title companies also conduct escrow, but independent escrow companies are the SoCal norm. Northern California typically combines title and escrow through the title company.
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Q2. A rental property closes escrow on July 20. Monthly rent is $2,700. The tenant paid July rent on July 1. Using a 30-day month with closing day belonging to the buyer, how much rent credit does the buyer receive?
A) $2,700 B) $900 (seller's 10 days: $90/day × 10 = $900) C) $1,080 (buyer's days 20-31... wait — using 30-day month: seller days 1-19; buyer days 20-30) D) $990
Answer: D — Daily rate: $2,700/30 = $90/day. Closing day (July 20) belongs to the buyer. Seller owned days 1–19 (19 days × $90 = $1,710). Buyer is entitled to days 20–30 (11 days × $90 = $990). Buyer receives a $990 credit.
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Q3. An escrow holder receives conflicting instructions from the buyer and seller mid-escrow — the seller wants to cancel; the buyer refuses to release the deposit. What must the escrow holder do?
A) Follow the seller's instructions because the seller owns the property B) Follow the buyer's instructions because the buyer deposited the funds C) Hold the funds and take no action until receiving a court order, written mutual cancellation, or arbitration award directing disposition of the funds D) Return the funds to the buyer automatically after 30 days
Answer: C — The escrow holder is a neutral party. When instructions conflict, the escrow holder cannot unilaterally decide the dispute. They must interplead the funds (deposit into court) or hold them until the parties reach a written resolution (mutual cancellation) or a court/arbitrator orders disposition.
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Q4. Property taxes on a home in Sacramento are $7,200/year. Escrow closes on September 1 (buyer's day). The first installment of $3,600 (covering July 1–December 31) has NOT been paid. How much does the seller owe in property tax proration?
A) $3,600 (full first installment) B) $1,200 (seller owns July 1–August 31 = 62 days × $20/day = $1,240) C) $7,200/2 = $3,600 D) $1,240 (July 1 through August 31 = 62 days; daily rate $7,200/360 = $20; $20 × 62 = $1,240)
Answer: D — Annual taxes: $7,200. Daily rate using 360-day banker's year: $7,200/360 = $20/day. Seller owns July 1 through August 31: July = 30 days + August = 31 days = 61 days (or 62 including the closing convention — depends on method). Using 30-day months: July 30 days + August 30 days = 60 days × $20 = $1,200. The seller owes a proration debit of approximately $1,200–$1,240 depending on the counting method.
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Q5. A real estate broker wants to open a general escrow business in California that handles third-party transactions (not just the broker's own deals). Can they do this under their real estate license?
A) Yes — a California real estate broker license automatically authorizes escrow services B) No — a broker may conduct escrow ONLY when acting as the agent in the transaction; to operate a general escrow business, the broker needs a separate escrow company license from the DFPI C) Yes — but only for residential transactions under $1 million D) Yes — as long as the broker maintains a separate trust account for escrow funds
Answer: B — Real estate brokers may conduct escrow only in their own transactions (as the agent for one of the parties). To operate a general escrow company accepting third-party transactions, the broker needs a separate license under California's Escrow Law, regulated by the DFPI.