What is an Escrow Account & How Does it Work?

If your business deals in high-ticket items, either as a buyer or a seller, your business and its cash flow requires a degree of assurance. In some high-value transactions such as real estate, art, vehicles or jewellery, non-payment from a customer can have a devastating impact on your finances. Likewise, if you make big-ticket capital investments on behalf of your business, you need to know that you’ll get the goods you’ve paid for quickly so they can start making you money. 

Escrow provides assurance at both ends of the transaction, minimising risk and facilitating trust between buyer and seller.

But what is escrow? And how does it work? Allow us to explain...

What is escrow?

Escrow is a financial agreement whereby a third party escrow agency or officer acts as an intermediary between two parties who take part in a transaction. The escrow agency takes control of the money and tangible or intangible assets that are to be exchanged until the conditions of the transaction’s contract are met. 

Escrow is used when the buyer or seller (or both) needs extra reassurance that both parties will live up to their obligations under the transaction’s contract.

What is an escrow account?

An escrow account is set up by an escrow agency in which both the seller and buyer (or their solicitors) are joint account holders. 

Escrow accounts are often used to hold money, securities, funds or any other kind of asset, providing protection for all parties. An escrow agency will collect fees from both parties, which are usually expressed as a percentage of the transaction’s value. 

Examples of escrow

There are numerous instances where an escrow account may be used in both your professional and personal life. Here are three of the most common.

Mortgages and real estate

Escrow accounts are commonly used when buying and selling property. When a buyer puts down a deposit, the funds are placed in escrow while they carry out their due diligence checks on a home, investment property or commercial property. If, for instance, the homebuyer’s report reveals something that could compromise the sale, the buyer knows that their deposit is protected. 

Stock market

When you buy and sell stocks, these are also often issued in escrow. When stocks are issued to employees as a bonus, they must usually wait for an escrow period to pass before they have the option to sell their stocks. 

Online sales

Online selling connects businesses to a huge global market instantly. But it can also represent a degree of risk when making high-value sales. Particularly when you’re selling to someone you know nothing about. 

Online escrow platforms act as an intermediary, withholding payment until the product has been received. Once delivery has been verified, the escrow officer will release payment to the seller.  

Pros and cons of escrow

As we can see, an escrow account can provide reassurance and help to facilitate high-value transactions. But is there a downside to relying on escrow? Let’s take a look at the pros and cons:

Advantages of escrow

• Provides protection for both the buyer and the seller, ensuring that a satisfactory result is attained for both parties and potentially improving the likelihood of future transactions

• Allows high-value commodities to be traded safely and mitigates risk

• Can potentially allow for taxes and insurance to be paid monthly rather than as a lump sum

Disadvantages of escrow

• Escrow fees can impact on profits. For online sales, escrow fees may be more expensive than using an intermediary like PayPal

• Using escrow for taxes and insurance can result in higher mortgage payments

• There’s a risk of overpaying or underpaying into an escrow account 

We can help

If you’re interested in finding out more about escrow, escrow accounts, or any other aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.