An escrow is typically defined as a neutral third party that will hold and release funds once agreed-upon conditions have been met. Escrows can be used for almost any transaction, especially those involving an exchange of money or ownership of property.
An escrow account is set up to help protect buyers from sellers who have something to hide, such as a history of not fulfilling contractual obligations. It’s usually initiated by the seller, and the funds for the purchase are held in trust until certain criteria are met. In this article, we’ll take a look at what an escrow account is, how it works and why you’d need one.
What’s in an escrow?
In the simplest terms, an escrow is a third-party controlled account that is used to pool money for a real estate transaction. This money is held by a neutral third party, such as a lawyer or broker, and disbursed according to the conditions specified in the contract. When the transaction is completed and all conditions are met, the money is released from the account.
We can dissect the escrow process more precisely by looking at its different elements:
- The contract – The contract between the buyer and seller details the sale of real estate, the price and other terms of the deal. This is where the idea of an escrow account is first introduced as a way to pool the money for the purchase.
- The escrow holder – The escrow holder is the person who manages the account and disburses funds once the sale closes. They are often a lawyer, real estate broker or title company.
- The escrow account – The escrow account is the neutral third-party account used to pool the funds for the purchase.
- The disbursement conditions – The disbursement conditions are the terms that must be met before the money in the account is released to the seller.
How does an escrow work?
When you buy real estate, you probably have a friend or family member co-sign the mortgage with you. Your co-signer is taking a big risk, so they will likely require you to put down a deposit, perhaps 10% of the purchase price. This is where the escrow account comes into play.
The seller will establish the escrow account as a condition of the sale. The escrow account is set up to hold your deposit, a portion of which is disbursed to the seller when they deliver the deed to the title company. The remaining amount is disbursed to you once the title company confirms that the seller has completed the transaction.
Why are escrows necessary?
Contracts are agreements between two or more parties. When the terms of a contract are met, both the buyer and seller are obligated to complete the transaction. However, there are times when one party does not meet their obligations. This may happen for any number of reasons. It’s possible that the seller does not own the property in question, or that the seller does not have the funds to complete the sale. In such cases, the buyer may be at risk of losing money or the property itself.
However, when a neutral third party is involved, both parties are more likely to meet their obligations. This is because the parties know that any breach of contract will be noticed, documented and corrected by the third party. The third party may, for example, withhold funds until both parties have satisfied their contractual obligations. If a party does not fulfill its contractual obligations, the third party will have the power to withhold their funds until the party corrects their mistake.
Who can be an escrow holder?
The choice of the escrow holder depends on the type of transaction. If it’s a residential purchase, the title company is likely to be the escrow holder. For commercial real estate transactions, a commercial closing attorney may be the escrow holder.
The escrow holder decides how much money goes into the account and when it gets released. The escrow holder will also make sure that both the seller and buyer have fulfilled their contractual obligations before releasing funds to either party.
Final words: is the use of escrows still necessary?
In short – yes. Even though technology has come a long way, it’s still not foolproof. An online transaction could encounter a technical glitch, or hackers may try to steal sensitive information. In addition, both parties could be in different parts of the world and face difficulty communicating. In such circumstances, a third party is needed to ensure that both parties meet their contractual obligations.
The escrow process ensures that both the buyer and seller meet their obligations. This is particularly important when the two parties are in different parts of the world and cannot communicate easily with each other. If you want to get a better understanding of what escrow is and how it works, it’s essential to contact a real estate lawyer. They will be able to explain the process in plain language and provide you with the advice you need to make the most of the escrow process.