So are you wondering what is the purpose of escrow as you are finalising a financial transaction and you’ve been advised to use an escrow agent?
Essentially, escrow is the legal and temporary holding of valuable assets or money by a third party on behalf of two other parties concluding a sale.
Keep on reading as we cover the topic below.
What Is an Escrow Account?
Managed by impartial escrow lawyers or entities, these accounts typically hold in trust the assets and funds of a buyer and seller finalising a transaction.
The money, property, and/or assets will be released if and when both parties satisfy the agreed-upon terms and conditions and fulfil their obligations.
Note that escrow agents must act in the best interests of both parties, and they must also keep the paperwork in order and ensure the funds are easily accessible.
Types of Escrow Accounts
While primarily used for real estate transactions, escrow accounts can also be opened for a variety of other financial transactions, including but not limited to the following:
- Property acquisitions
- Mortgage agreements
- Renting contracts
- Construction deals
- Online transactions
- Buying stocks
- Acquiring intellectual property
- Trading in fine art
Note: Regardless of the situation, the goal of the escrow process is to ensure sellers receive their payment while buyers get the goods, assets, or property in proper condition.
What Are the Requirements for an Escrow Account?
Before signing an escrow agreement, all interested parties will be required to disclose the condition of the transactional goods and furnish information such as:
- The identity of the escrow agent,
- Clarification of the relevant definitions,
- The funds to be held in escrow,
- The exact prerequisites for release,
- Responsibilities of the parties involved,
- Applicable liabilities, fees, and expenses,
- Jurisdiction in the event of legal actions.
Note: While the list above includes the general requirements of an escrow agreement, they may still vary depending on the exact circumstances requiring such a contract.
What Is the Benefit of Having Escrow?
Naturally, the main benefit of hiring an escrow agent during valuable transactions is the assurance that the deal will conclude fairly and legally for all parties.
However, additional benefits may also apply depending on the type of escrow you have.
For instance, if you obtained a home loan to buy a house in Australia, you can open an escrow account with your mortgage lender to release funds for the relevant taxes and insurance costs on your behalf, thus guaranteeing all relevant bills will be paid on time.
Any Disadvantages of Escrow Accounts?
While escrow accounts are ideal for successfully finalising any number of financial transactions, they may include some drawbacks under certain circumstances.
As an example, if you have an escrow agreement attached to your home loan, your mortgage payments will be higher than expected to cover related bills.
Also, you might miss out on short-term investment opportunities as your money will be inaccessible, and you may have to provide a larger up-front payment.
Escrow Accounts in Real Estate
Escrow agreements are best used in real estate transactions as they involve vast amounts of money, valuable paperwork, and numerous obligations imposed on both the seller and the buyer; and below, we cover the main situations that necessitate escrow accounts:
1. For Independent Buyers & Sellers
So how does escrow work when buying a house in Australia?
Let’s say you found the house of your dreams but are unsure if the seller will fix it up or accept your offer. In such cases, you put a down payment in escrow to show you want to buy the property and to incentivise the seller to keep up his end of the bargain.
On the other hand, the existing owner places the property deed in escrow to be transferred in your name when the entire house payment gets processed.
Also, sellers must approve the appraisal, home inspection, and maintenance processes, while buyers must collect their savings and get financing and insurance policies.
Once every interested party meet their obligations, the transfer of ownership and the release of funds, documents, and assets can proceed as planned.
Note: While escrow agents ensure everything is completed on time, you may also have to prepare yourself for settlement delays as they happen more often than not.
2. For Real Estate Companies
One of the less common types of escrow accounts is the real estate escrow agreement that is signed when you arrange a house purchase via a real estate company.
Essentially, to ensure you will not redirect your funds towards other expenses, real estate agents require you to deposit a symbolic sum in escrow, which will only be released if an unexpected life crisis stops you from purchasing the home property.
3. For Renters & Landlords
Escrow accounts also come in handy when signing rental agreements as it helps keep both the landlord and the renter honest regarding their duties towards each other.
For example, suppose there is a regular disruption in the apartment’s basic utilities. In that case, tenants can simply put their rent amount in escrow to speed up the necessary repairs, as the monthly instalments will only be released once all issues are fixed.
However, landlords may also require a security deposit to be put in escrow as protection against renters that violate their agreement and/or cause damage to the property.
Did you know: Renting is an excellent temporary solution, but there are ways to save up for your first home while renting.
4. For Construction Work
This type of escrow account is used to settle a transaction between homeowners and contractors for homes that are being constructed or remodelled.
Typically, the contracting company lists the construction stages and the costs associated with each, and it will receive funds after the completion of each step.
Note: Learn how much it costs to build a duplex in Australia in our thorough guide.
Hopefully, now that you know what is the purpose of escrow, you understand the importance of entrusting your assets and/or funds to an impartial third party. That way, you’ll complete every transaction smoothly, securely, and quickly. After all, every interested party will be required to confirm the escrow terms so that everyone is treated fairly.
1. Who owns the money in an escrow account?
While the money, documents, and other assets are held temporarily by the escrow agent, they are technically still in the possession of their original owners and change ownerships only after the interested parties conclude their transaction.
2. Can I withdraw money from an escrow account?
Typically, no party may voluntarily withdraw money from an escrow account, whose management is left to the discretion of the escrow agent.
3. Is it better to have escrow or not?
Since you’ve learned what is the purpose of escrow from the sections above, you know that such accounts are essential for most transactions involving money and valuable assets.