The word “escrow” surfaces in almost every real estate transaction. What, actually, is an escrow, and why is it important?
“Escrow” in the context of a real estate transaction refers to an arrangement in which a third party holds a valuable item during the transaction, to be delivered to another party when specified conditions are satisfied. Valuable items held by the third party are typically money (for example, an earnest money deposit or a purchase price), and documents (for example, a deed). There are many variations on this basic “escrow” theme, and the term “escrow” has many uses within this basic framework:
- Escrow Agreement. The conditions under which the third party will accept and release the escrow are often, though not always, spelled out in a written agreement. This written agreement can be a separate contract, sometimes called an “escrow agreement.” Alternatively, the understanding concerning the escrow can be included in the written contract that governs the transaction, such as a Purchase and Sale Agreement.
- Escrow Agent/Escrow Holder. The third party with whom the valuable items are deposited is very often referred to as the “escrow agent” or “escrow holder.” The escrow agent is frequently, though not always, a neutral party who is compensated for their service.
- Escrow Account. When funds are deposited into escrow, the account in which the third party holds the deposited funds is typically referred to as an “escrow account.”
- Escrow Instructions. When parties deposit money, documents, or other property with the escrow agent, they often do so accompanied by “escrow instructions” that state the conditions under which the deposit into escrow is being made, and under which the escrow agent will be authorized to release the deposited property from escrow.
- Opening of Escrow. “Opening of escrow” can mean when the parties and the neutral third party have all executed the agreement that will govern the escrow, or it can mean when the neutral third party first accepts the deposit of the valuable item, which is most frequently money placed in the escrow account.
- Close of Escrow/Closing. “Close of escrow,” also frequently called “closing,” most often means that the real estate transaction has been completed. It typically includes the disbursement of funds from the escrow account and release of documents held by the neutral third party.
Neutral third party escrow agents can facilitate transactions because they have no stake in the transaction outcome and will presumably keep the parties’ property safe and follow the instructions in the escrow agreement. The presence of the neutral third party allows the parties to deliver funds, documents, and other property confident that the funds, items, or documents deposited will be released and applied according to the terms of their contract. The neutral third party can also enable the parties to the transaction to exchange these valuable items and consummate their transaction without actually attending a sit-down “closing,” which in itself can be of significant value.
In cases in which the property interest is not ultimately conveyed—for example when the contract is terminated—the neutral third party facilitates the unraveling of the parties’ relationship by, for example, disbursing deposited funds to the appropriate parties and returning executed documents to the parties who deposited them. Procedures to be followed in the event that the contract is terminated are commonly included in the agreement that establishes the escrow.
Many real estate transactions span a long period of time between the parties’ execution of a contract and the conveyance of the property interest. Transactions can involve multiple deposits and disbursements of funds, and include intricate conditions to be satisfied by the parties, both before and after the property interest is conveyed. The neutral third party facilitates each of these steps.
The duties of an escrow agent can include:
- Managing the deposited funds and/or documents in accordance with instructions
- Paying property expenses (e.g., real estate taxes) as authorized
- Allocating costs of closing according to the parties’ agreement
- Closing the escrow only when all conditions have been satisfied
- Distributing the deposited funds according to the escrow agreement
- Recording and distributing transactional documents
An “escrow” can exist after the closing as well. In a typical post-closing escrow, funds are held to pay for the performance of work, expenses not yet known, or for other items occurring after the closing date (such as real estate taxes). Funds in a post-closing escrow can be deposited by either party, or they can come from another source. When the funds in the post-closing escrow are taken from the purchase price, the post-closing escrow is sometimes called an “escrow holdback” (because some of the purchase price is being “held back” from the seller and dedicated to specified post-closing purposes). Post-closing escrows can also involve the deposit of documents to be released upon the occurrence of conditions that won’t be satisfied until after closing.
When mortgage lenders are involved, the term “escrow” can refer to funds collected in advance and held by the lender to make payments for expenses such as property insurance and real estate taxes.
In practice, there are many varieties of escrow: Not all escrows are formal, not all escrows involve neutral third parties, and not all escrows involve a written agreement. Less formal escrows frequently occur in real estate transactions, such as when the attorney for one party accepts delivery of signed documents from another party “in escrow” pending the receipt of signatures on the documents from all other parties. These less formal escrows are often based on unwritten understandings, underlying principles of common law, and professional trust.