Escrow Payment Definition
Escrow payment can be said as a legal concept involving a financial arrangement in between three parties whereby a third party agrees to hold an asset or money on behalf of other two involved in a particular transaction at a given time, and for the purpose of this arrangement, an escrow charges a certain sum of money as commission or fees and keeps the transaction secure by managing and fulfilling predetermined contractual obligations.
Types of Escrow Payment
There are seven types, which are as follows.
- Internet Escrow – Under this arrangement, a licensed independent third party agrees to keep the money for safeguarding the interest of both buyer and seller.
- Banking – Under this arrangement, a machine is used, which holds money—for example, ATMs and vending machines, etc.
- Intellectual Property – Under this escrow arrangement, the third party holds source code for safeguarding the interest of both customers and suppliers.
- Law Escrow – This type of arrangement is used to distribute funds from an announced cash settlement in an environmental enforcement action or class action suit.
- Real Estate Agreement – This type of escrow payment arrangement is used to pay for real estate properties and hazard insurance.
- Merger & Acquisitions – Under this escrow payment arrangement, warranties and indemnities are offered by selling parties, usually used when credit risk of the seller is not of good quality.
- Gambling – Under this type of escrow arrangement, parties who have gambled on a particular event handovers money to a neutral third party who makes payment after the occurring event as per the fixed terms and conditions.
Examples of Escrow Payment
Here we can see some examples.
Imagine a person owes a total of $3000 per year in property tax and $1800 for insurance premium, to get the monthly escrow payment amount we need to add this tax and premium expense then divide the result by 12.
Monthly Escrow Payment = ($3000 +$1800) / 12 = $400
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Imagine two-person enters into an arrangement with third-person involving gambling escrow payment whereby first two-person bets on winning of two different out of ten horses running in a horse race. If either of both the horse wins the race, escrow agent, i.e., the third person who has been handed over possession of money will make payment to one of the people whose horse wins the race; otherwise, the money will be returned as it is after the deduction of escrow commission.
Therefore, as per the above terms and conditions, the third person will hand over money owner else will return it after the completion of a horse race. The escrow agent will earn commission in either of the case.
Some of the advantages are as follows:
- Under an escrow payment arrangement, both buyers and sellers ensure hassle-free transactions.
- The escrow agent independently verifies the article or service provided before the occurrence of a transaction.
- Two parties involved in the transaction get rid of paperwork and have to just make the deal without wasting their time.
- The cost of arranging escrow payment is low, as the fees charged by the escrow agent are very nominal.
- With the help of an escrow account, taxes and insurance premiums can be paid in monthly installments instead of processing onetime payment.
- It is also useful from a credit rating point of view, which further helps in getting loans at lower interest rates from banks.
Some of the disadvantages are as follows:
- This type of arrangement requires the maintenance of significant monthly funds.
- Organizations having with fluctuating incomes may face a problem when they are short of funds.
- Money deposited in the escrow account gets locked, i.e., one does not have control over the money anymore.
- The money deposited in the escrow account cannot be withdrawn even when there is an emergency.
- This type of arrangement leads to a loss of interest on money kept invested in it. Although some escrow arrangements do provide interest, it is very minimal.
- With the changing technology, there are specific changes taking place in escrow payment arrangements also. One of the most critical changes is internet escrow under which a third party (the escrow agent) keeps the money to ensure the safeguarding of interest of both buyer and seller.
- Another recent most change in escrow payment transactions is the involvement of interest factors. Earlier, escrow agents didn’t use to provide interest on funds in possession, but now the concept is changing, escrow agents have started providing interest on finds in their possession.
- Innovations in types of escrow arrangements: As mentioned and explained above, now there are multiple types of escrow payments been arranged, and hence one may use as per his/ her requirements.
- With the increasing use of this arrangement, law and regulatory authorities are also focussing on developing rules and regulations for escrow payments to ensure smoothness of transactions.
It is a contractual arrangement between three parties whereby the third party agrees to keep money on behalf of the other two and make payments as per the contractual terms and conditions. There are different types of escrow payments like real estate, internet, law, intellectual, merger and acquisition, gambling, etc.
Escrow payment transactions help to ensure the security of transactions occurring as per terms and conditions. The cost of escrow arrangement may not be feasible at sometimes. With the changing business models, there are specific changes occurring in escrow payments. Also, due to increased volume, also for ensuring monitoring of transactions, there are legal rules and regulations in the course of development.
This has been a guide to Escrow Payment and its definition. Here we discuss types and examples of Escrow Payment along with advantages and disadvantages. You can learn more about financing from the following articles –