An escrow account is a temporary deposit held by a third party on behalf of two other parties, which is usually called an escrow agentю. The temporary account operates until the process of a transaction is complete and all conditions between both parties are settled. The money or other assets are debited from this account when the predetermined legal obligations are fulfilled or the escrow agent receives the instructions to release the assets.
Escrow account is designed differently than regular accounts. The major difference between an escrow account and other types of deposit accounts is its temporary nature as was opened to support a certain transaction. In addition, its management by the third party is not common among other types of deposit accounts.
Functions of escrow accounts
While escrow account can hold securities, funds, money and other assets, more often this temporary deposit is used in real estate transactions. It is used when a buyer wants to perform an inspection or any other due diligence on the property while assuring that he or she has enough funds to actually buy the property. This way, the seller can be confident that if the property corresponds to the description, the buyer will be able to buy it and the seller has not wasted his time and funds. On the other hand, the buyer can be sure that his money is safe in the escrow account and will be delivered to the seller only if he is satisfied with the conditions of the house and is ready to purchase it.
Utilization of an escrow account
An escrow account is also used between lenders and borrowers in mortgage transactions. Typically, lenders are the ones requiring deposits in escrow account made by the borrower on a regular basis. Deposits are used to pay real estate taxes as well as insurance. Another reason to use an escrow deposit in real estate transactions is when a property is only under construction, while a buyer already wants to reserve it for him or her. It is possible to deposit a certain amount of funds in the escrow account to make sure that by the time a building is ready, he or she will be first in line to get the craved property.
Escrow accounts are becoming more and more popular among business transactions as well. In this case, they substitute the letter of credit. Similarly as for other transactions, escrow service receives funds from the buyer and notifies the seller that the payment has been made. The seller then ships the goods to the buyer and when the buyer has received the goods and examined their quality, he or she confirms that the funds can be released and credited to seller’s account.
Escrow is also used by public companies, which give part of their shares to their employees, especially to top executives. Therefore, although employees are the shareholders, they are limited in their rights to use or sell the stocks. Often, after the stocks are received as a bonus, employees are unable to sell the securities while the escrow period has not passed. This is used in order to protect the shares’ market price as well as to deter the top executives from leaving the company.
Advantages & disadvantages of escrow account
Depending on the field of transaction, it is believed that both parties involved can benefit from escrow services. If discussing business transactions, both parties should be careful when choosing a proper and trustworthy escrow agent. As the funds are held by the third party, both parties involved need to be confident about their assets as they will be released when appropriate.
In real estate, it’s believed that the buyer or the borrower is at a worse position than the seller or the lender. As in case of regular deposits along with mortgage payments, the lender has to tie his funds instead of investing them, earning some return and paying the tax or insurance when needed. In addition, for people with fluctuating income, it could be difficult to ensure equal payments on a monthly basis.
It’s worth mentioning that while the depositing party is incapable to invest their funds, this option is typically used by escrow agents, who earn not only from service fees, but also by investing in short term financial instruments.
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