An escrow is when you place something of value in the care of another party and held until a certain condition is met.
For example, the online community is fraught with online scammers trying to pull a fast one on the next unlucky victim. There’s a beautiful new bandsaw you want to purchase. How can you trust the seller will send the bandsaw after you have delivered payment? The seller could live thousands of miles away making any form of legal action against them very complex. Flip the roles what if you were the one selling a beautiful antique piano. How can you trust that the buyer’s check they sent will be good and not bounce? How can you be sure that they won’t demand their money back after having the piano for only a few days? This is where an escrow comes into play. These may not be the most common uses of an escrow, but it helps to identify what exactly an escrow is. Simply put, you send the payment to a third party and they make sure that the rest of the transaction goes smoothly. The escrow account manager does not care who gets out on top, they are only there to ensure that the transaction happens fairly.
A more common use for an escrow is during a real estate transaction. The two most common situations is when an escrow account is used to hold a real estate buyer’s earnest money, and when the buyer sets up an escrow account to hold monthly payments for the purpose of paying for regular house expenses such as property taxes, hazard insurance (also called homeowners insurance), and private mortgage insurance (or PMI).
Essentially, a buyer will send money to an escrow agent, very often a real estate broker, where it is held in escrow and referred to as the earnest money. Earnest money is provided to show the seller that the buyer is serious about the purchase and that if the seller incurs any financial losses due to a breach of contract by the buyer, that there is money available to compensate the seller for their losses. Assuming every goes well, the earnest money will be released by the escrow agent and put towards the transaction price at the closing.
When someone purchases a home using a promissory note, and the bank providing the funds secures the promissory note debt by issuing a mortgage to secure that debt. Because the house is used as collateral to secure the loan, the lender wants to have the best chances possible to keep collecting the promised payments. Borrowers usually have property taxes that are due on a regular basis, and they are most often required by their lender to have and insurance policy to cover the house. Additionally loans where the borrower puts less than 20 percent down, are also required to pay Private Mortgage Insurance (PMI). If any of those payments were missed it could affect the bank’s ability to collect their payments. As a result banks Among the risks a lender tries to mitigate is the monthly payments a borrower pays. Home loan lenders often request the homeowner open an escrow account and put monthly amounts in to ensure that taxes and insurance payments are made on time. Those payments are made with homeowner’s regular monthly interest and principal payments. Principal and interest go toward the loan, and the rest goes into escrow where it is held until payments come due.