What is Escrow? Types, Examples, Pros and Cons

What is Escrow?

An Escrow is an arrangement whereby a third party holds an asset or escrow money on behalf of two other parties that are completing a transaction. Payments are kept in a third-party account and are only released when all agreement terms have been met. Using an escrow account in a transaction adds a degree of safety for both parties.

Money, funds, securities, and other assets can all be placed in escrow. Escrow accounts might incorporate escrow fees managed by agents who hold the funds or assets until receiving suitable instructions or until the fulfillment of predetermined liability obligations. Escrow is linked with real-estate transactions, but it can be applied to any situation where funds pass from one party to another. With real estate transactions, escrows can be used when purchasing a home and for the life of a contract.

The main objective of an escrow is to ensure that everybody keeps their end of the bargain. It can be considered an arbitrator of transactions. Here we will go through escrow, how it works, the different types, and the pros and cons.

Why use an escrow?

Escrow is commonly used for bargains that have the following characteristics:

• A significant transaction value, for example, purchasing a home
• The buyer must confirm the quality of work before payment
• The seller should not undertake the massive amounts of work without assurance of payment.

An escrow is also advantageous when the transaction can be completed in steps. It would be unwise for the buyer to pay the full payment before completing the project, as the service provider may need funds to continue the project. However, funds can be paid partially as predetermined tasks are completed.

How to use an Escrow?

Real estate Escrow

Escrow is often used in real estate investments. It protects the buyers from online scams. The buyer would be able to check if the property being purchased is of standard as advertised and if there was no malicious attempt of a seller to scam him. In the absence of this service, the buyer is taking a considerable risk in that there is little to stop the seller from cashing the check without the buyer's knowledge about the transaction.

How does an escrow work in real estate?

The estate buyer transfers funds to an escrow provider (third party). If all the terms and conditions of the transaction are met, the funds would be further transferred to the property seller. If not met, then either half funds are transferred to the seller, or they all are returned to the buyer.

Online Escrow

While performing an online transaction, there is little transparency on who we are dealing with. Due to this reason, the online third parties who offer internet escrow services to protect both the buyer and seller are licensed. Terms and conditions are agreed upon and submitted to the third party, including the purchase amount, allowable return period, and time for goods to arrive. Once all requirements are fulfilled and are agreed upon by both parties, the online escrow service provider finalizes the transaction by transferring funds to the seller. Online escrow charges a fee for the service.

Whenever there are some controversies, a dispute resolution protocol ensures the transparency of the transaction. The protocol will decide who will keep transactions. With the increase in cybercrimes, fraudulent online services have increased. One must be cautious and ensure that the service provider is reliable and not someone with a malicious aim.

Escrow and stock market

Stocks are commonly issued in escrow. Like real estate escrow and Online escrow, stock market escrow safeguards the buyer and seller from fraud or non-payment. In the stock market escrow, the shareholder is the actual owner of the stock, but he has limited rights for the disposal of stock. For instance, executives who receive stock as a bonus for their compensation usually have to wait for an escrow period to pass before they can sell the stock. Stock bonuses are a tactic used to keep top executives.

Pros and Cons of Escrow

Pros

• Escrow protects a transaction, especially a real estate transaction (which tends to be huge)
• Allows for the monthly payment o insurance and taxes
• It safeguards the buyer and sellers when high tickets are involved.
• If there is any issue found during the transaction and sales fall through, the buyer will receive earnest payment back in line with the agreement.

Cons

• If escrow is used for taxes and insurance, this requires high mortgage payments.
• For online transactions, escrow charges high fees compared to other platforms, such as PayPal.
• Estimates may be incorrect for the amount of taxes. So you may end up underpaying or overpaying into your escrow account, which may lead to an adjustment when it comes time to make the annual payments.

The Bottom line

Money from the buyer is kept in an escrow account until the transaction is complete and all terms are met, or the buyer can verify the condition of the product. Once the buyer coincides with the transaction, the payment is released to the seller from the escrow account. Escrow is commonly used for various transactions, including real estate, online sales, and stock market issuances.