You have probably heard the phrases “fell out of escrow” or “in escrow” in reference to buying or selling a house, but the escrow process exists in more than just the real estate industry. Here is a guide to the financial buzzword and the different types of escrow.
The term “escrow” is used in many areas, including real estate, banking, online sales, law, mergers and acquisitions, and intellectual property. But no matter where it’s used, the meaning of escrow essentially stays the same, according to Investopedia writer Caroline Banton.
“Escrow is a legal concept describing a financial instrument whereby an asset or escrow money is held by a third party on behalf of two other parties that are in the process of completing a transaction,” she reports.
The third party is not the buyer or seller, but rather a neutral third party, according to The Balance writer Justin Pritchard. This third party is responsible for keeping paperwork, funds, or other assets for the buyer and seller until they meet the contract’s demands. Escrow is typically used in complicated transactions. “The escrow provider acts as this middleman and ensures that the buyer and seller do what they agree to do,” says Pritchard.
Real estate acquisition
Real estate transactions are complicated for both the buyer and seller. Typically, the process is lengthy and expensive. Escrow provides necessary time for the buyer to do what is necessary in order to purchase the home, while also allowing the seller to satisfy any requirements from the buyer to complete the sale.
“If there are conditions attached to the sale, such as the passing of an inspection, the buyer and seller may agree to use escrow,” explains Banton.
Buying and selling on the internet has become safer and more reliable over the years, but it still comes with a level of risk. If you want to protect your interest in an online transaction, it is important to set specific terms, including price, shipping agreement, and return window, advises Pritchard.
“If you enlist an escrow service for that sale, after providing those details to the service, the buyer and seller just need to do what they agreed to do,” he adds.
If you currently play the stock market, receive shares from your employer, or are hoping to reap dividends in the future, you might come across the term escrow. According to Banton, stocks are often issued in escrow, and although as the shareholder you own the stock, you don’t have free rein to dispose of it. Just like in a real estate transaction or online sale that warrants an escrow service, stocks are held until certain conditions are met.
“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,” Banton adds.
Escrow can help protect a range of transactions, most notably high-stakes and high-risk. Before you enter escrow, be sure you can handle the conditions as well as any third-party fees necessary to complete the deal.