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 buyer and seller, and lender and borrower. They can be individuals or companies.
Escrow is therefore defined as a cash deposit, a bond or any financial instrument to ensure that no funds are paid to anyone unless all terms and conditions of the contractual agreement are met. Sometimes an escrow does not necessarily cover all terms and conditions of a contract, but covers just one clause.
Escrow: Within Context of Real Estate
Within the context of real estate, escrow is synonymous to closing or settlement. When an individual sells his house to another person, the buyer agrees to put funds into an account which will be held by an independent party (trust company, lawyer, or a 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. In other words, by agreeing to open an escrow account, the parties demonstrate their sincere intention to proceed with the transaction.
In a property sale, buyer and seller meet to sign the documents. If everything is in order, the seller of the property has to provide clear title and other relevant ownership documents, while the buyer will have to come up with the funds to seal the sale. This is why in real estate transactions an escrow is often referred to as the closing.
In North America, escrow is common practice. You usually hear about it in real estate negotiations, but the escrow principle is being applied in other domains of activity. For instance, in bidding or outsourcing platforms, a buyer will request a specific project to be executed. He posts this on the bidding board and a provider who is interested in doing the job will begin communications with the buyer. In most cases, when it is a large scale project, the service provider will request the buyer to deposit funds into the escrow account.
The escrow serves to protect both buyer and provider. If the provider does a sloppy job, the buyer can refuse to authorize the release of the funds. And for the provider’s part, knowing that the buyer has deposited funds into escrow demonstrates his serious intent to go ahead with the project, ahd hence won’t be doing work 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 his interest to purchase. The buyer knows that many buyers will be interested in his property. But how does he know which one is the most serious? It is the buyer who puts a deposit with a third party and has a document showing proof of deposit. Also, it relieves the seller of worries about the buyer’s financial capability to purchase the property.
Sometimes, the escrow can be opened to ensure that the seller will undertake repairs or improvements to the property before he is paid. When the funds are released, that means the seller has met all of his obligations, including submitting the required documents.
Importance of Escrow
Escrow is important to ensure that neither buyer nor seller backs out at whim. If the seller goes back on his word because another buyer offered a higher price, the escrow serves to protect the interests of the original buyer so that he does not lose any cash when the seller suddenly decides not to sell to him. Likewise, a buyer may withdraw his offer because he found another property which he liked better and so backs out of the deal. In the meantime, the seller has already told other prospective buyers that his property has been sold. This causes him to lose time and money and may demand compensation for lost opportunities.
Your Escrow Agent or Officer
Escrow has to be entrusted to:
- a third party that is not a friend or relative of either buyer or seller. This is to ensure that there is no conflict of interest.
- when 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 in 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 satisfied, the escrow goes into closing.
Provinces and States may have different views about 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 monies and safeguarding the documents as stipulated in the instructions,
- disbursing payments for all bills (with authorization from the parties),
- corresponding with the parties regularly and
- closing the escrow when buyer and seller shake hands after the deal is completed.
The escrow agent must then submit a detailed listing of debits and credits of the escrow fund – also called a closing or settlement statement.
Who Appoints The Escrow Holder?
Both buyer and seller must agree to the appointment of an escrow agent. If a real estate agent is handling the sale of the property, he or she can recommend an escrow officer or title company.
Regardless of who does the choosing, both buyer and seller must ensure that the escrow officer is qualified. They are within their rights to insist on competence, reliability and experience. No referral fees are paid – at least not in those 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 is a direct sale? Either buyer or seller can open escrow. As a buyer makes an offer for the property, the buyer hands the seller a check as a sign of his good faith. The buyer then deposits this check with a closing agent and is considered to be an “open” escrow, complete with a file number. An escrow officer is assigned to take care of the check and will be involved in the whole process until closing. Since this officer is your contact at the title company, you must communicate with him regarding all matters relating to the escrow: funds, payments, obligations, progress reports/statements.