what is an escrow

Escrow

Clients have been asking what an Escrow is, what is it used for and how is it obtained.

An escrow is an agreement between several parties and is an instrument to settle payments from one party to another. There will be between two and four parties in an Escrow account. An Escrow instrument involves the Escrow holder, also known as the paymaster, the purchaser, the seller, and the funder. The Escrow holder is a person such as a Lawyer, an Accountant, or a person held in trust by one or all of those mentioned.

Are there costs involved in setting up and using an Escrow, the answer is yes, and depends on the Escrow holder. The Escrow holder manages the funds or assets and charges an agreed fee.

An escrow is normally used to settle cash transactions between one party and another, the easiest example here is purchasing a house using a mortgage, in this case, the Escrow holder is the purchaser's Lawyer, after paying down a refundable deposit the purchaser then secures the balance through a bank or a mortgage company, the funds are then paid into the Escrow holder, the seller through his lawyer places the asset, the house into the Escrow holder, the Purchaser has already signed an agreement for the mortgage, this is placed with the Escrow holder, the buyer and seller then contract a purchase and sale agreement, this document is then placed with the Escrow holder. Once all the conditions are fulfilled the Escrow holder releases the funds to the seller, the asset to the purchaser, and the deeds to the fund’s provider. The Escrow holder’s job is then complete. The purchaser will then start to pay down the debt until it is cleared, and the mortgagee will then hand over the deeds to the purchaser.

Most large financial and or asset transactions involve the use of an Escrow agent. However, this is normally an automatic process, and it may not be mentioned there is an Escrow in place. The use of a Lawyer in any purchase transaction is an Escrow.

 

KEY TAKEAWAYS

  • Escrow is the use of a third party, which holds an asset or funds before they are transferred from one party to another.
  • The third party holds the funds until both parties have fulfilled their contractual requirements.
  • Escrow is associated with real estate transactions, but it can apply to any situation where funds will pass from one party to another.
  • With real estate, escrow can be used when purchasing a home, but also for the life of a mortgage.
  • Online escrow has been on the rise to offer secure transactions for high-ticket items, such as art or jewellery.

 

Understanding Escrow

Escrow is a process used when two parties are in the process of completing a transaction, and there is uncertainty over whether one party or another will be able to fulfill their obligations. Contexts that use escrow include Internet transactions, banking, intellectual property, real estate, mergers and acquisitions, law, and many more.

Consider a company that is selling goods internationally. That company requires assurance that it will receive payment when the goods reach their destination. The buyer, for their part, is prepared to pay for the goods only if they arrive in good condition. The buyer can place the funds in escrow with an agent with instructions to disburse them to the seller once the goods arrive in a suitable state. This way, both parties are safe, and the transaction can proceed.

For real estate, there are two escrow accounts—the first is when you’re buying a home, and the other is for the life of the mortgage.

 

Types of Escrow usage

Escrow and Asset Transactions, housing, vehicles, commercial property, etc

Escrow accounts can apply to buying and selling of a house or an asset. Placing the funds in escrow allows the buyer to perform due diligence on a potential acquisition. Escrow accounts also assure the seller that the buyer can close on the purchase. For example, an escrow account can be used for the sale of a house. If there are conditions attached to the sale, such as the passing of an inspection.

In this case, the buyer of the property deposits the payment amount for the house in an escrow account held by a third party. The seller can proceed with house inspections confident that the funds are there, and the buyer can make payment. The amount in escrow is then transferred to the seller once all the conditions for the sale are satisfied.

Escrow can also refer to an escrow account that is set up at the time of mortgage closing. With this, the escrow account houses future homeowners’ insurance and property tax payments. A portion of the monthly mortgage payment is deposited into the escrow account to cover these payments. Thus, mortgagees that set up an escrow account (in some cases it's required by the lender) will have higher payments than those who do not; however, they will also not have to worry about paying the yearly premiums or property tax bills as they're already paying it monthly into their escrow account.

 

Escrow and the Stock Market

Stocks are often issued in escrow. In this case, while the shareholder is the real owner of the stock, the shareholder has limited rights when it comes to the disposal of the stock. For example, executives who receive stock as a bonus to their compensation often must wait for an escrow period to pass before they can sell the stock. Stock bonuses are a tactic used to retain top executives.

 

Escrow and Online Sales

Online escrow, like real estate and stock market escrow, protects the buyer and seller from fraud or non-payment. An online platform acts as the middleman for online product sales. The buyers send the money to an escrow service, such as escrow.com, and they hold the money until the product is received. 

Once the product is delivered and verified, an online escrow provider will release funds to the seller. For the most part, escrow services are not used; however, in cases that it is, it’s generally best suited for high-ticket items, such as jewellery or art. The online escrow company charges a fee for the service.

 

Advantages and Disadvantages of Escrow

Escrow can provide security for high-ticket transactions, but that service generally comes with a fee. Escrow for mortgages can help protect the borrower and lender from potentially underpaid property taxes or homeowners’ insurance. 

On the downside, these numbers are generally estimated, so you may end up overpaying (or underpaying) into your escrow account, which may lead to an adjustment when it comes time to make the annual payments. For the ease that monthly escrow payments offer, this requires a higher mortgage payment than if the payment only included principal and interest.

Pros

  • Provides protection during a transaction, notably a real estate transaction (which tends to be sizable).
  • Can allow for the monthly payment of insurance and taxes (avoiding having to pay a lump sum).
  • Escrow is beneficial for both the buyer and seller when high-ticket items are involved.

Cons

  • Higher mortgage payments (if escrow is used for taxes and insurance)
  • Estimates might be incorrect for taxes.
  • For online transactions, escrow fees might be higher than other platforms, such as banks.

 

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