You might not know this, but “finances” are one crucial thing that needs to be handled with care. A financial transaction between two parties is not as simple as it may sound to you from the outside. Financial transactions between two parties need to be done carefully in a way that requires involving a separate, mostly neutral, party through escrow.
Escrow is a common practice in our country that ensures a safe and timely transaction of cash and property – from one party to another. If this is your first time hearing about the word, or you are just unsure of it, don’t worry; we’re here for you. Here, we have compiled a detailed guide for you to know all about escrow.
What is an Escrow?
Escrow is a legal concept where we can use a financial instrument at the time of a transaction between two parties. It is an agreement between the two parties (buyer and seller) during their transaction process to instill a third party on their behalf to hold the paperwork, asset, or money – whatever that is being transacted, till the deal is finalized and the transaction is complete.
In this case, the third party is known as the “escrow provider” who ensures a safe and sound asset transaction from the buyer to the seller. The escrow provider stays part of the deal until both the parties have met their obligatory deals – and this is one reason why escrow is essential. There is always the uncertainty that at least one party will not be able to fulfill their contractual obligations.
How Does Escrow Work?
Do you think financial transactions work with one pat agreeing to sell a particular product while the other party agrees to pay for it –and that is how the deal closes? Because most financial transactions are much more complicated than this. There are situations when the buyer wants to inspect the product or property before paying for it, or the seller needs to make sure that they will, in fact, be paid by the end of the contract – hence this is where we need an escrow.
Some Examples to Understand Escrow
- For example, imagine you have ordered goods from a certain place, and you want to make sure they’re in perfect condition before you pay for them. Similarly, the seller also wants to make sure that they will be paid the correct amount of money once the goods are received. Hence, this is where they may need an escrow to ensure a smooth transaction process.
- Another example could be giving a contract to a certain company to fix and remodel your washroom in exchange for a considerable amount of money. But instead of giving money at the completion of work, you decide to pay once you are satisfied with the result. This is a contradicting situation; hence you will need a “referee,” also known as the escrow provider, to ensure a smooth transaction in this case.
Types of Escrow
There are three major types of escrow: escrow and stock exchange, escrow, and real estate, and online escrow. Let’s get to know more about them.
1. Escrow and Stock Exchange
Stocks are very commonly used in escrow – here, even though the stockholder is the real owner of the stock, in reality, they have minimal rights when it comes to the disposal of the stock. Suppose you are an executive and you receive stock as a bonus to your compensation. Now you have to wait for a certain escrow period to end before you can sell this stock. This is why it is a well-known fact that these stock bonuses are just tactics to retain high-end, top executives.
2. Escrow and Real Estate
Escrow is a financial agreement that can also apply to real estate transactions. In fact, it is quite beneficial for the buying party as well – because while you place the fund in the escrow, you have the perfect opportunity to perform due diligence in case of a potential acquisition. Hence, an escrow can be used for selling a house with a signed agreement that includes different conditions such as the passing of inspection and satisfaction.
The escrow contract is signed, and once the buyer deposits money in the escrow account, the seller can proceed with their overview of the property. Till then, their money is safely held by escrows until the sellers are satisfied with all the conditions applied – the money is then transferred from the escrow account to the seller account and the real estate transaction is closed.
3. Online Escrow
Like the other two types, online escrow also protects buyers and sellers from non-payment and potential fraud. An online platform is issued in this type of escrow, which acts as a middleman for online sales. The buyers send money to the escrow service (which can be a website); these escrow providers hold the money until the product is received. Once the buyer receives the product and it is checked and verified, the escrow provider will release the amount.
Pros and Cons of Escrow
Everything has some advantages and disadvantages – here are the pros and cons of using escrow accounts or providers.
- Ensure safety and protection in case of a big transaction (especially a real estate transaction)
- It is beneficial for both; the buyer and the seller – because both sides have their conditions.
- It also allows monthly payment of taxes and insurance
- Estimates can be incorrect for the amount of taxes
- The mortgage payment can be high if escrow is used for tax and insurance
- For online transactions, escrow fees can be higher than on other platforms
Escrow is a financial tool that allows a third party to control the payment between two separate parties. While the concept looks simple, it is quite complex and needs full understanding before investing your money. However, no doubt, having a third-party escrow account can ease the transaction process and ensure the safe transfer of money, especially when the escrow is a neutral party and has no concerns with the money on each side.