If you’ve bought or sold property at any point in your life, you’ve probably heard the term “escrow” thrown around. You also may know that it is also a vital component of many business-to-business (B2B) transactions. But, what exactly is “escrow”?
At its core, the concept is simple: Escrow is a neutral third party that holds money, titles, or anything of value to ensure the buyer and seller involved in a transaction meet their obligations for the transaction to take place.
Think of it like a referee — or a middle man who’s a real stickler for the rules.
Why do people and businesses need escrow? Because most large transactions are complex, and with that complexity comes risk. Escrow is an attempt to hedge against that risk. Take for example the process of buying property. The buyer has some obligations to the seller, and vice versa. You need a system in place to ensure those obligations are met. So you put something — typically earnest money — into escrow to make sure both parties hold up their end of the bargain.
Given that, you can imagine how escrow could be useful in other large, lengthy transactions outside the world of real estate, especially in B2B transactions. Here, we breakdown the ins and outs — from types of escrow services to the fees associated with them.
How do businesses use escrow?
If you find yourself operating a business, it won’t be long before you find yourself needing escrow services. These services are generally required when large sums of money are being transferred between businesses. This could be anything from a purchase of assets to an acquisition or merger. The details of these large transactions can take time to settle, so the funds for the transaction need to be kept in a safe place to ensure delivery when the transaction is complete.
These services can be used by business for many types of transactions, but they are most common on mortgages and other property transactions.
Property and Mortgage Escrow
As you learn quickly when you buy a home or an office building, there’s so much more to the cost than the actual cost of the property.
Most mortgages require the buyer to make a down payment and pay closing fees to complete the transaction. After that, the buyer is usually required to hold insurance on the property, as well as pay property taxes to local and state government. Often, those payments are assessed annually, and, equally as often, lenders need assurances that buyers will pay those costs when the time comes.
These are examples of situations where mortgage escrow comes into play. Funds are set aside in the mortgage escrow account to reduce the risk that they won’t be available when the time comes. These services are critical for buyers and sellers to protect their interests while the transaction is being negotiated and finalized.
What about escrow fees?
It’s true; protection rarely comes for free.
When it comes to real estate transactions, costs vary by state, but generally you will pay an escrow agent a percentage of the cost of the property. The party responsible for those fees — the buyer, the seller or both — also varies by state.
At the end of the day, it’s all about securing your investments — whether that be the purchase of a new home or software to build your business. And that’s something we can get behind.