What is an escrow account and how does it work?

Apr 05, 2024

People who have bought or sold houses would be familiar with the term ‘escrow account for business transactions’. For others who doesn't know what is an escrow account and how does it work, this account is majorly used when there is a huge transaction between two parties.

Business escrow accounts hold money temporarily till the conditions laid down before the transaction are met. The usage of escrow bank accounts is more common in real estate.

Other than that, they are also used in circumstances like mergers and acquisitions, selling/buying stocks, and making online payments where buyer and seller don’t know each other.

What is an escrow account?

Let’s assume a real estate situation where a home is listed for sale. The buyer has confirmed the purchase and is ready to pay the money.

But before spending a large sum, they should do due diligence to confirm everything that the seller claims are true.

From the seller's perspective, they cannot make another prospect wait. If the buyer is truly interested in the property, they can place the funds in the business escrow accounts through a third party escrow service.

The seller can withdraw from the escrow when the buyer has done their audits and is satisfied with the purchase.

How does an escrow account work?

Knowing how does an escrow account work is pretty important for business owners as it can be handy while making large-scale and important investments. Be it any purchase, there is a risk associated with the sale.

The asset might not be in a good condition, the delivery could be delayed, or any possible worse case can pan out. To protect the buyer’s money and get its worth, escrow.com (or any third party escrow service) offer the escrow account for business transactions.

The buyer can put the reserves in the escrow account to confirm their purchase. When a purchase happens, buyer and seller agree on certain terms and conditions.

The escrow payment will continue to remain in the business escrow account until the seller fulfills every condition and request.

Since the amount safely resides in the escrow account, the seller can focus on the finishing works as promised and the buyer can receive the asset in perfect condition, just as expected. The amount in escrow is protected and monitored by the respective escrow third-party service.

Other than money, business escrow accounts can also hold assets, properties, and other funds. For using this service, one should have opened an escrow account paying annual escrow account fees.

Benefits of escrow account

Escrow services aren’t offered free of cost. Before you splurge your money, you must know the pros and cons of having an escrow account and making escrow payments.

Ensures that the company is free of any liens

Only after making sure that the prerequisites are fulfilled do the funds in the escrow bank account get released. After the funds reach the seller, the buyer gets complete rights over the acquired property.

Because of this payment nature, you can be assured that there won’t be any acquisition of assets after releasing the funds.

Offers financial protection

Using an escrow account for transactions safely cascades your money to the seller and offers utmost protection to it till it gets handed over. Considering the size of the payment, any theft or fraudulent activity in-between can lead to the loss of funds.

Using an escrow account for business transactions, you put an end to the above speculations.

Transactional risks are reduced

There have been moments where business owners have faced a huge loss while sending consignments to an unknown seller. Buyers face a different kind of risk where they cannot be sure about the current state of the asset.

An escrow payment favors both the buyer and the seller in this situation, reducing the transactional risk that can possibly arise.

Strengthen the buyer's and seller's trust

It can be hard to accept that everything on the internet cannot be trusted. In the case of an international transaction, the buyer can neither meet the seller nor see the asset. It’s natural for them to be hesitant about the authenticity of the sale or purchase.

With business escrow accounts in place, both buyer and seller can comfortably proceed with the transaction and other pending responsibilities.

Enables easier documentation and online tracking

Business escrow accounts simplify your whole online payment system. You can always monitor what’s happening with your money and hold its control till it reaches the seller. Your accounting team will have no trouble as escrow payments require minimal documentation.

Allows transactions to be tailored to specific needs

The buyer doesn’t have to place the entire fund required to complete the purchase in an escrow bank account. If the buyer relies on banks or lenders to sanction the money, they make terms with the sellers on the required escrow payment.

A percentage of the asking price will be kept as the minimum escrow payment needed to be made by the buyer.

Disadvantages of escrow account

There are some unavoidable disadvantages of escrow account

Higher fees than other platforms

If you are using escrow services to make online payments, you should know that it can be a little more expensive than other payment methods you use to make international transactions.

Typically, a buyer will pay 1% to 5% of the asset’s final price as the escrow account fees. Along with this, add the service fee of the escrow officer who guides you throughout.

Risk of overpaying or underpaying

After finishing the purchase, you will keep depositing the property tax and insurance premium every month into the escrow account. At the end of the year, this money will be collected by the mortgage company and the tax and the insurance will be paid on your behalf.

This breakdown of costs makes your escrow payments either high or low if you use them for paying property taxes and insurance, which can be done without an escrow account too.

Inaccuracies in price estimation

Insurance premium costs and property taxes can vary over a period of time.

Since the estimation of escrow costs on the above categories is done based on the current market prices, there can be inaccuracies and fluctuations in the total amount collected at the end of the year.

If the buyer has paid more than necessary, the mortgage company will reimburse the extra money. But if the collected amount is lower than the required amount, the buyer is solely responsible to pay the difference.

The seller or buyer doesn’t earn interest on the funds

If you usually send funds over a medium, it gets instantly delivered to the receiver or there might be a small expected delay.

Nevertheless, with an escrow account for business transactions, it is held for a certain amount of time till it reaches the other party. Even though this is a huge amount of money, there are no possibilities to earn interest for the time it gets stored in escrow.

Tips to consider before choosing an Escrow provider

Every escrow service provider functions differently and has different pricing plans. Here is what you should know before choosing one and locking your funds away.

Secure transaction and storage of your assets

There are plenty of providers who offer this service at low escrow service fees. But you cannot compromise the security of your resources by choosing the wrong provider.

Most importantly, you choose escrow bank accounts for safer transactions of your funds. Choosing a well-reputed and experienced escrow service is significant to not fall prey to theft and forgery.

Do your research to find out the top escrow operators in your region who has strong reviews and a star customer base. Make sure you list down the business escrow accounts with FDIC insurance and are backed by your local government.

Though FDIC insurance can limit the maximum amount you deposit to $250k making it hard for large-scale transactions in millions of dollars, premium escrow service providers can make it possible to extend your limits.

Don’t lock your funds for nothing in return

Business owners know the value of money/assets and are actually keen on growing it as time goes by. The huge funds you put away for a temporary time period can actually yield more outcomes, if it’s invested somewhere else.

Additionally, keeping funds locked away while incurring escrow account fees is plainly an expense. In general, escrow payments don’t render additional pecuniary benefits.

However, there are modern financial institutions with proper technological layout and they can help you earn returns. Ultimately, your goal should be to find a less-risk, high-gain pathway to safely transact your funds.

Fund release timings and expected delays

When all the liabilities are met and the buyer agrees to close the escrow and release the funds on the mentioned date, the service provider will take that as an affirmative.

But there can be expected delays especially while releasing funds in large quantities. And in many cases, buyers have faced unrevealed liabilities and concerns with the purchased asset.

But they cannot reverse the funds that are already released. So, it’s wise to know if the provider releases the funds at certain delays or if they can release them in parts. This is because the seller will be in need of funds to finish specific documentation works.

Business escrow accounts are crucial when it comes to making M&A and other large-scale transactions. It’s a huge relief for business owners when they receive the asset in perfect condition.

They can also hold the seller responsible for taking care of agreed terms before purchase. Since it’s a win-win situation for both parties, the escrow account for business transactions is becoming more popular among investors and entrepreneurs.

Keep in mind the above-discussed points while choosing your third-party escrow provider for a smooth and infallible procurement experience.

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