To understand the concept of escrow, think “deposit in trust.” This is the essence of escrow. When two parties enter into an agreement, the purpose of escrow is to protect the interests of both parties. It covers any commercial transaction between a buyer and seller or a lender and borrower. These parties can be individuals or companies.
Escrow is defined as a cash deposit, bond, or any financial instrument that ensures no funds are paid to anyone unless all terms and conditions of the contractual agreement are met. Sometimes, escrow does not cover all terms and conditions of a contract but may only cover one specific clause.
Escrow: Within the Context of Real Estate
In real estate, escrow is synonymous with closing or settlement. When an individual sells a house to another person, the buyer agrees to put funds into an account held by an independent party (such as a trust company, lawyer, or title company). When both buyer and seller have met their respective obligations, the buyer then requests the trust company or lawyer to release the funds to the seller. By agreeing to open an escrow account, the parties demonstrate their sincere intention to proceed with the transaction.
In a property sale, the buyer and seller meet to sign the documents. If everything is in order, the seller must provide clear title and other relevant ownership documents, while the buyer must provide the funds to finalize the sale. This is why escrow is often referred to as the closing in real estate transactions.
Escrow Dynamics
In North America, escrow is a common practice, primarily known in real estate negotiations, though the escrow principle applies to other domains as well. For instance, on bidding or outsourcing platforms, a buyer may request a specific project to be executed. The buyer posts this on the bidding board, and a provider interested in the job will begin communication. In most cases, when it’s a large-scale project, the service provider will request the buyer to deposit funds into the escrow account.
The escrow serves to protect both the buyer and provider. If the provider does a subpar job, the buyer can refuse to authorize the release of the funds. On the other hand, the provider knows that the buyer has deposited funds into escrow, showing the buyer’s serious intent to proceed with the project, ensuring the provider won’t be working for nothing.
It works the same way in real estate. A homeowner advertises his house, an interested buyer visits the property, discusses the terms of sale, and then expresses interest in purchasing. The buyer knows that many buyers may be interested in the property. But how does the seller know which one is most serious? It is the buyer who puts a deposit with a third party and provides a document showing proof of deposit. This also relieves the seller of concerns about the buyer’s financial capability to purchase the property.
Sometimes, escrow can be opened to ensure the seller undertakes repairs or improvements to the property before payment is made. When the funds are released, it means the seller has met all his obligations, including submitting the required documents.
Importance of Escrow
Escrow is important to ensure that neither the buyer nor the seller backs out on a whim. If the seller goes back on his word because another buyer offers a higher price, escrow protects the original buyer’s interests, ensuring he doesn’t lose any cash when the seller suddenly decides not to sell. Likewise, if the buyer withdraws his offer because he found another property he likes better, the seller may have already informed other prospective buyers that his property has been sold. This causes the seller to lose time and money and may demand compensation for lost opportunities.
Your Escrow Agent or Officer
Escrow must be entrusted to:
- A third party that is not a friend or relative of either the buyer or seller, ensuring there is no conflict of interest.
- When the buyer and seller agree on a deal, a document will be drafted, signed, and then delivered to the escrow officer or agent for safekeeping.
- Clear and detailed instructions must be provided to the trustee (escrow agent or lawyer) so he knows what to do at each stage of the transaction.
- The escrow is then processed; the escrow officer will establish escrow based on the instructions he received.
- When the conditions of the sale have been met, the escrow process moves to closing.
Provinces and states may have different views on an escrow officer’s duties and responsibilities, but there are common denominators:
- Execution of instructions provided by the parties in a timely and efficient manner;
- Managing the funds and safeguarding the documents as stipulated in the instructions;
- Disbursing payments for all bills (with authorization from the parties);
- Corresponding with the parties regularly;
- Closing the escrow when the buyer and seller finalize the deal.
The escrow agent must then submit a detailed list of debits and credits of the escrow fund – also called a closing or settlement statement.
Who Appoints the Escrow Holder?
Both the buyer and seller must agree on the appointment of an escrow agent. If a real estate agent is handling the sale, they can recommend an escrow officer or title company.
Regardless of who chooses, both the buyer and seller must ensure the escrow officer is qualified. They have the right to insist on competence, reliability, and experience. No referral fees are paid – at least not in states or provinces that prohibit the payment of such fees in the interest of consumer protection.
What if there is no real estate agent and it’s a direct sale? Either the buyer or seller can open escrow. As the buyer makes an offer for the property, the buyer hands the seller a check as a sign of good faith. The buyer then deposits this check with a closing agent, creating an “open” escrow, complete with a file number. An escrow officer is assigned to handle the check and will be involved in the entire process until closing. Since this officer is your contact at the title company, you must communicate with them regarding all matters relating to the escrow: funds, payments, obligations, and progress reports/statements.
