Escrow - Explained
How does Escrow Work?
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Table of ContentsWhat is Escrow?How does Escrow Work? Escrow in Real EstateStock Market: Use of EscrowAcademic Research on Escrow
What is Escrow?
Escrow is a legal concept which refers to the holding or hoarding of a financial instrument by a third party on behalf of two different persons that are on the verge of completing a transaction. An escrow agent is basically in charge of these financial instruments until stated, wherein this third party entity would be required to give out the payment to either of the parties (usually the receiving party) or will have to hold the money until a designated contractual obligation is fulfilled.
Escrows can be used to hold money, securities, funds and other assets which are being used as payments for rendered services or transactions.
- Escrow refers to the utilization of third party firms or individuals in holding funds or assets and securities before theyre transferred from the sending party to the receiving party.
- Basically, the third party takes possession of these instruments until each party involved in the transaction will have satisfied their part of the deal.
- Escrow is generally used in any transaction that involves transferring funds from one party to another upon completion of projects, however, it is basically active in real estate transactions.
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How does Escrow Work?
Escrow refers to a holding process where two parties are in the process of concluding a transaction and there exists uncertainty between the parties regarding the sincerity of each other. Typical examples of transactions that require escrows are internet transactions (where the sending party might have no prior relationship with the receiving party), banking, intellectual property and real estate amongst others. In businesses, escrows can be applied to mergers and acquisitions, as well as law.
For instance, let us assume that a client is looking for someone to design a product for his or her business. He or she jumps onto a designing platform and starts up a contract with one of the designers available or provided by this platform. Since the client doesn't know the quality of this designers job or doesn't know if his work can meet his demands, he can opt to make payments to an escrow agent who will only release the funds to the designer upon the clients directives.
In this case, the escrow agent would basically be the platform where the client met the designer. Also, the designer would prefer to work via escrow since he or she has no prior relationship with the client, and there is a chance that the client wont pay upon deliver even if he or she is satisfied with the deliverable. Thus, this designer would opt for an escrow agent who will only release the funds to him or her upon the clients approval. Escrow agents basically operate substantially in the real estate sector, but they can also be applied to other financial transactions where a party is in need of assurance of the sincerity of the counterparty.
Escrow in Real Estate
Most real estate transactions make use of escrow accounts in completing contracts. Putting payment funds in escrows allows the buyer to perform his or her duties on a potential acquisition. It also builds up assurance in the seller since he or she knows that the buyer can fulfill payment of the property in question.
A typical instance where escrow can be used in real estate transactions would be in the sale of a home. If a home put up for sale is required to undergo physical inspection, the buyer can opt to place funds in an escrow account in wait for the results of the inspection.
In a situation like this, the funds would only be released when the inspection results are favorable both to the buyer and seller and if they meet certain conditions. Escrow also allows the seller to proceed with the inspection knowing that the buyer is capable of covering the cost of the property if the result meets the requirements agreed upon by both parties. If all conditions are met, the escrow agent is then required to transfer the funds to the seller.
Stock Market: Use of Escrow
Stocks are issued in escrows in most cases, and it usually occurs when the shareholder is the original owner of a stock but has limited rights when it comes to transferring or disposing the stocks to others. An instance would be in the case of an executive who receives a bonus in the form of company stocks. This executive officer wont automatically be granted access to the stock, although he is already the new owner of the stake. The stock about would be deposited into an escrow and the executive can only sell it off when a specific period of time has elapsed. Top executives are usually retained using stock bonuses.
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