What is escrow and how does it work?
In: Economics
The Bank doesn’t trust you to pay all the taxes and legal fees and other random payments etc (nor do you want to) that may come up over life of loan so they ask you to pay extra money every period that sits in an escrow account they can use to pay those random taxes etc without annoying you first. At end of loan they’ll pay back whatever is left in the escrow account
In most contexts, it means holding someone else’s money in an account you own or someone holding your money in their account.
Usually, there are rules requiring that people holding funds in escrow have a specific account for that purpose at the bank, as opposed to keeping it in the same account that they use to run their business.
Escrow accounts are often used by lawyers, accountants, real estate brokers, and others who handle people’s money.
Another example, you (or your mommy and daddy since you’re five) are buying a house with cash (kinda’ unrealistic these days, but it’s simple). You have a bank account and the seller has a bank account. You, or your title company or real estate agent, opens a third bank account, called the “escrow account”. You put the cash for the house sale into that third account. The seller can’t touch it (yet).
Then, after 30 or 45 days, assuming all went well, the escrow company closes the escrow account and transfers the money to the seller, and the title company hands you the keys (usually indirectly). So when someone says “we closed on our new house today” it means just what I described above. The escrow bank account gets closed, the seller gets the cash, and you own the house by virtue of the title company transfering the property title to your name and handing your the keys, which you throw away after changing the locks.
It’s a little more complicated when there’s a lender, like a mortgage company, involved, but the mechanics are largely the same.
Escrow is someone trusted by both sides to hold the money until the transaction is complete. It can be a bank, a lawyer, a friend, a government, a broker.
I want to buy your car but I don’t trust you to give me the keys if I give you the money first. You don’t trust me to give you the money if you give me the keys first. But we both trust James so I give him the money and once you give me the keys he gives the money to you. While James has the money he’s holding it in escrow.
Yet another example, probably not what you’re thinking of. It’s called “software in escrow.” Say you have a software company and you’re a start-up. A customer wants to purchase your software but doesn’t trust that you’ll stay in business for long, since, as we know, most start-up fail. They don’t want to be lecft with zero chance of support. So as a part of the software purchase contract, they require you to put your source code into escrow. This means that you use a software escrow company and you put a copy of the source code to the software you sold to that customer into the hands of that escrow company. Then, if your company goes out of business, your source code is made available to that customer who purchased your system and they can at least support themselves.
I’ve encountered this many times, and it’s a PITA for the software start-up, packaging up the source code in a way that some random customer can build it for themselves.
Bottom line, your software source code is being held by a third party (you are the first party, the customer is the second party) in what is called an “escrow account.” So escrow isn’t just for money like in the other examples described here.
Escrow basically means money held by a neutral third party. Most commonly, you’ll hear of it connected to buying or owning a home. During a home purchase, the buyer typically puts up earnest money along with the initial offer and part of the down payment once the inspection and other contingencies are met, and that money is held in an escrow account — neither the buyer or seller has direct access to the money.
Once one buys a home, the mortgage servicer typically collects money into an escrow account with each monthly mortgage payment in order to pay the homeowners insurance and property taxes when they are due. In this case the mortgage services is the 3rd party between home owner and those receiving the annual/semi-annual payments.
TLDR you owe money on house, bank pay taxes and property tax for you. Some of your money goes to interest, some to principal, some to escrow which does the above
Building construction sometimes have escrows with the township to ensure that the project isnt half finished if the contractor goes bankrupt. The township doesnt necessarily care if the new building gets completed, they care if the contractor digs a giant hole for the basement and then just leaves. The township escrows the money so that if the contractor gives up on the project, that the township can use that money to pay someone to come and clean up the site just enough where its safe to the public.
(Im missing some info but that’s the ELI5 version)
You’ve got lots of good answers here. But escrow is basically a trustee person that can facilitate a transaction amongst two potentially untrustworthy people. When I sold my software company to another company, it had to go through escrow. I think escrow charged 1% of the purchase price. But they took the contract and made sure both sides lived up to it. The buyer sent all the money to the escrow agent, and we sent all the domain names, software packages, code, etc to the escrow agent as well. Once they verified both parties did what they said they would do, they gave us the money, and they gave the seller all the software. If one of us would have not fulfilled the contract, they would have reversed it (but kept the 1%).
Without the escrow agent, you can get into issues as one side has to make a move before the other. Like if I sent the seller the domain name for my business, but they never followed through with the cash, now my company is dead but I have no money.
Another good example of escrow being used was with darkweb markets.
You would purchase something on a marketplace that looked something like eBay. Your money would be transferred to the site until a certain amount of time would pass or you said the product was received. If nothing came up then the money would be sent to the seller. If there were issues then the money would be returned or split ect. Perfect way of doing things.
The biggest scams would be when the sites did “exit scams” on which they held off paying people for a bit, allowing a decent amount of money to build up in escrow. Then they’d close down and leave with the money. In legal stuff there would be more you could do, but in this kind of thing you just had to hope it didn’t happen. A fantastic system when it worked, frustrating when it didn’t
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