What is Escrow
An escrow is:
1. an arrangement where an independent trusted third-party holds money for two transacting parties, with the timing and direction of release of the money by the third-party dependent on how certain pre-specified future events unfold, or
2. an account established by a broker, under the provisions of license law, for the purpose of holding funds on behalf of the broker's principal or some other person until the consummation or termination of a transaction;or,
3.a trust account held in the borrower's name to pay obligations such as property taxes and insurance premiums.
The word derives from the Old French word escroue, meaning a scrap of paper or a roll of parchment; this indicated the deed that a third party held until a transaction was completed.
Types
Escrow generally refers to money held by a third-party on behalf of transacting parties. It is best known in the United States in the context of real estate (specifically in mortgages where the mortgage company establishes an escrow account to pay property tax and insurance during the term of the mortgage).
Escrow companies are also commonly used in the transfer of high value personal and business property, like websites and businesses, and in the completion of person-to-person remote auctions (such as eBay), although the advent of new low cost online escrow services has meant that even low cost transactions are now starting to benefit from use of escrow. In the UK escrow accounts are often used during private property transactions to hold solicitors' clients' money, such as the deposit, until such time as the transaction completes.
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Internet escrow
Internet Escrow has been around since the beginning of Internet auctions and commerce. It was one of the many developments that allowed for trust to be established in the online sphere.
As with traditional escrow, Internet escrow works by placing money in the control of an independent and licensed third party in order to protect both buyer and seller in a transaction. When both parties verify the transaction has been completed per terms set, the money is released. If at any point there is a dispute between the parties in the transaction, the process moves along to dispute resolution. The outcome of the dispute resolution process will decide what happens to money in escrow. With the growth of both business and individual commerce on the web traditional escrow companies have been supplanted by new technologies.
In the EU, the Payment Services Directive which commenced on 1 November 2009, has for the first time allowed the introduction of very low-cost Internet escrow services that are properly licensed and government regulated. The regulatory framework in the EU allows these web-based escrow services, which operate along the lines of expensive Letter of Credit service run by banks for international buyers and sellers, but at a cost in cents rather than thousands of Euros, the ability to enhance security in commercial transactions.
Bogus escrow methods have been employed online. In an effort to persuade a wary Internet auction participant, the perpetrator will propose the use of a third-party escrow service. The victim is unaware the perpetrator has actually created an escrow site that closely resembles a legitimate escrow service. The victim sends payment to the phoney escrow company and receives nothing in return. Alternatively, the victim sends merchandise to the subject and waits for his/her payment through the escrow site which is never received because it is illegitimate.
Banking
Escrow is used in the field of automated banking and vending equipment. One example is automated teller machines (ATMs), and is the function which allows the machine to hold the money deposited by the customer separately, and in case he or she challenges the counting result, the money is returned. Another example is a vending machine, where the customer's money is held in a separate escrow area pending successful completion of the transaction. If a problem occurs and the customer presses the refund button, the coins are returned from escrow; if no problem occurs, they fall into the coin vault.
Intellectual property
Source code escrow agents hold source code of software in escrow just as other escrow companies hold cash. The highly valuable (and often secret) source code is only released by the agent to either party upon specific terms of the escrow agreement (such as failure to maintain the application, transfer of ownership of the intellectual property rights, or the liquidation of the owner of the source code). Information escrow agents hold in escrow intellectual property and other information. Examples include song music and lyrics, manufacturing designs and laboratory notebooks, and television and movie treatments and scripts. This is done to establish legal ownership rights, with the independent escrow agents attesting to the information's ownership, contents, and creation date.
Law
Escrow is also known in the judicial context. So-called escrow funds are commonly used to distribute money from a cash settlement in a class action or environmental enforcement action. This way the defendant is not responsible for distribution of judgment moneys to the individual plaintiffs or the court-determined use (such as environmental remediation or mitigation). The defendant pays the total amount of the judgment (or settlement) to the court-administered or appointed escrow fund, and the fund distributes the money (often reimbursing its expenses from the judgment funds).
Real estate
Escrow payment is the common term referring to the portion of a mortgage payment that is designated to pay for real property taxes and hazard insurance. It is an amount "over and above" the principal and interest portion of a mortgage payment. Since the escrow payment is used to pay taxes and insurance, it is referred to as "T&I", while the mortgage payment consisting of principal and interest is called "P&I". The sum total of all elements is then referred to as "PITI", for "Principal, Interest, Tax, and Insurance". Some mortgage companies require customers to maintain an escrow account that pays the property taxes and hazard insurance. Others offer it as an option for customers. Some types of loans, most notably Federal Housing Administration (FHA) loans, require the lender to maintain an escrow account for the life of the loan.
The monthly escrow payment is calculated by taking the total of all anticipated tax and insurance disbursements for the coming year, and dividing that number by 12. In addition, if the mortgage company requires a minimum balance in the escrow account (usually no more than double the monthly escrow payment), they may add on a shortage adjustment so that the balance never falls below the minimum balance requirement. If, even at its lowest point, the escrow account has a projected balance greater than the minimum balance requirement, federal guidelines—the Real Estate Settlement Procedures Act of 1973 (RESPA)—require that the mortgage company refund the difference to the customer.
Even with a fixed interest rate, monthly mortgage payments may change over the life of the loan due to changes in property taxes and insurance premiums. For instance, if a hazard insurance premium increases by $120.00 per year, the escrow payment will need to increase by $10.00 per month to account for this difference (in addition to collection for the resulting escrow shortage when the mortgage company paid $120.00 more for the hazard insurance premium than what was anticipated). By RESPA guidelines the escrow payment must be recomputed at least once every 12 months to account for increases in property taxes or insurance. This is called an escrow analysis.
Licensed Escrow Companies
The only way to avoid escrow fraud is to use a licensed escrow company. These companies are regulated by national or state authorities and are required to have bonds that ensure customers can recoup money lost in the escrow process.
The only way to be certain an online escrow company is licensed is to see where they claim to be licensed and check with that government authority. Usually, there will be an online database of companies that can be searched by going to the licensing institution's official website.
Legal implications
Not all escrow agreements impose the duties of a legal trustee on the escrow agent, and in many such agreements, escrow agents are held to a mere gross negligence standard and benefit from indemnity and hold harmless provisions.
If the escrow agent is licensed by governmental authority, then much higher legal standards may apply.
