What Is Escrow?

Escrow Explained

Definition

An escrow is a financial agreement in which a third party controls the money and property of two transacting parties and only releases both when all of the terms of a given contract are met.

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How Escrow Works

When you commit to buying or selling something, you agree to fulfill certain terms. For example, the buyer must pay the agreed-upon amount by a specific time, and the seller must provide the asset being sold. Of course, some transactions are more complicated than that. For example:

  • Buyers might want the right to inspect the property or goods they are buying before paying.
  • Sellers might want some assurance that they'll get paid (or have the opportunity to move on if the deal isn't happening quickly enough).
  • The asset being sold might be a service instead of a product.

In complicated arrangements like these, one party may feel unsure that the other will meet their end of the bargain, creating the need for a third party to act as a "referee." The escrow provider acts as this arbiter and ensures that the buyer and seller do what they have agreed to do.

Note

Ideally, the escrow agent or provider is a neutral third party who isn't concerned with whether the buyer or seller comes out ahead. Given the assets at stake in big transactions, look for a trusted provider, such as a big-name escrow company or a provider recommended by your real estate agent or other professional you trust.

The escrow provider's responsibilities in a transaction include receiving assets from one party, disbursing funds according to the terms of the escrow agreement, and closing escrow. Their role in the transaction safeguards the assets of buyers and sellers before they get transferred from one party to the other.

Here's an example. Say you hire a contractor to remodel your kitchen for a large sum of money. You can place the funds to be paid with a third party agent at a bank, and form a contract to release the money to the contractor once the work is completed, with a clause that defines satisfactory completion. This type of arrangement serves everyone. The contractor has assurances that they will be paid, and you have assurances that the work will be completed to your satisfaction.

How To Choose an Escrow Service

If you're buying a house, choosing an escrow service may be one of the easier decisions you'll have to make. You'll probably go with the service your agent recommends. But if you need an escrow provider for some other kind of transaction, you'll have to find one your own. Start with referrals and a review of local escrow providers. Then learn more about those provider and their reputations. Here's how:

  • Visit your state's escrow agent licensing authority: You'll learn about the rules and regulations, and you may be directed to lists of licensed or qualified agents in your area. For example, California's Department of Financial Innovation and Protection offers consumer's information about license types, and where to find lists of agents, depending on the type of escrow service required.
  • Research the provider: You can search for a prospective escrow provider online with the word "complaint" to dredge up any negative reports. Likewise, check to see whether the provider must be licensed in the state in which it operates—and then confirm that it is licensed.
  • Meet your provider: If possible, meet the people who will provide the escrow service. You'll be able to ask questions directly, and you'll get a sense of their professionalism.

Note

For real estate transactions, buyers and sellers typically split the cost of escrow. Escrow, or "closing" fees are often 1% of the sales price of the home, although some providers may charge a flat rate.

Types of Escrow

Escrow can be used in any number of financial and legal scenarios where something of value exchanges hands, but it frequently applies to real estate and online transactions.

Real Estate Escrow

Escrow is common when you buy or sell a home. It begins when a signed agreement is delivered to an escrow agent, who ensures that the conditions of the contract are all satisfied. For example, the officer might verify that home inspections, disclosures, and objections are completed or resolved on time. Escrow closes when the purchase money is disbursed to the seller, and the title is recorded in the name of the buyer.

An earnest money deposit is probably the first time you’ll interact with an escrow agent in a home sale. The buyer writes a check payable to the escrow holder, who will either refund the money, apply it to the purchase price, or pass forfeited funds on to the seller if the buyer fails to meet the requirements of the contract.

Note

If a buyer pays a seller directly instead of going through escrow, the buyer would take a significant risk. In that case, there would be little to stop a dishonest “seller” from cashing the check immediately and making it difficult for the buyer to complete the purchase.

Homeowner Escrow Accounts

This type of escrow account is one where assets are held by a third party to make sure that you meet agreed upon obligations. Escrow accounts are commonly used for monthly payments on a home.

Your monthly house payment probably includes expenses such as homeowner’s insurance premiums and property taxes in addition to the interest and principal of your loan. These are often annual expenses (although insurance companies may accept monthly payments), but lenders can’t always be confident that homeowners will budget for them properly. Lenders protect themselves by requiring that homeowners cover the cost of insurance and taxes via escrow.

After all, if you don’t have homeowner’s insurance, your house could burn down, leaving it worth less than you owe. Likewise, if you don’t pay your taxes, the local taxing authority could put a lien on your home and collect taxes due at a sale or foreclosure. If that happens, your lender would only be able to collect what’s left after the taxes are paid.

Note

If your lender doesn't set up an escrow account for you, you will need to budget for these monthly expenses on your own. For this reason, you might request an escrow account even if your lender doesn't require one.

Online Escrow

Escrow services are useful for more than just home purchases.

Online sales can be risky. Whether you are a buyer or a seller, you’re dealing with somebody you don’t know, and they might be many miles away, so taking legal action against a swindler would cost too much to be worth it.

There are a few ways to make online transactions safe:

  • Trading in marketplaces where buyers and sellers have a reputation can improve the odds of completing a safe, successful transaction.
  • If you’re a buyer, make use of your credit card’s consumer protection features.
  • A third approach (which protects both buyers and sellers) is to have an escrow service handle the transaction.

If you enlist an escrow service for a sale, the buyer and seller just need to do what they agreed to do in the initial contract. If the seller never ships anything, the buyer gets their money back from the escrow provider. If the buyer says the goods never arrived, the seller and escrow company can review shipping confirmations. If the buyer agreed to complete the transaction based on those confirmations and there’s proof of shipment, then the escrow provider pays the seller, and the transaction closes.

Key Takeaways

  • An escrow is a financial agreement in which a third party controls payments between two parties and only releases the funds involved once a contract's terms are met.
  • An escrow service temporarily holds money, paperwork, or other assets for a transaction on behalf of the transacting parties.
  • An escrow provider should be a neutral third party who isn't concerned with whether the buyer or seller comes out ahead in the agreed transaction.
  • Escrow frequently applies to real estate transactions.

Frequently Asked Questions (FAQs)

Why am I paying escrow every month?

Your monthly house payment includes the interest and principal on your mortgage, and it probably includes fees for homeowner's insurance and property taxes. These are usually annual fees, but many lenders require borrowers to pay them monthly. These payments go into an escrow account and held there until they are disbursed to cover insurance premiums or taxes.

What is escrow real estate?

Escrow is an arrangement between a home buyer and seller in which funds for the transaction and right to own the home are held by a third party: the escrow agent. The escrow agent verifies that all of the terms of the contract are followed, documents signed, fees paid, and so on. Escrow "closes" when the terms are met; funds then transfer and the property is conveyed to the buyer.

Updated by
Lars Peterson
A photograph shows Lars Peterson.
Lars Peterson is a veteran personal finance writer and editor with broad experience covering personal finance, particularly credit cards, banking products, and mortgages. He has been writing and editing for more than 20 years and has a knack for digging deep into a subject so he can make it easier for others to understand. As an editor for The Balance, he has assigned, edited, and fact-checked hundreds of articles.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Cornell Law School: Wex. "Escrow."

  2. California Department of Real Estate. "Surviving the Real Estate 'Escrow' Process in California: Important Things and Tips You Should Know, and Mistakes to Avoid," Page 25. 

  3. California Department of Financial Innovation and Protection. "Escrow Law: Consumer Information."

  4. Zillow. "How Much Are Closing Costs for Sellers?"

  5. Consumer Financial Protection Bureau. "§ 1024.17 Escrow Accounts."

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