Personal Finance

What is escrow and how do you use it? Simple guide to types of escrow

what is escrow

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An escrow account is always required when the assets of a person, the so-called trustor, are to be managed by a trustee. It is usually managed as a bank account, for example as a deposit, current account, savings or time deposit account. But what does escrow mean? To explain the escrow meaning, we outline what is escrow, the different kinds of accounts and how you can use escrow for mortgage and other transactions.

What does in escrow mean? It simply means that a sum of money is being held in an trust account for use later on. This is referred to as the money being ‘in escrow’.

What is escrow? Here is a simple escrow definition

What is an escrow account and what is special about it? To define escrow simply and differentiate it from a normal account: With a conventional current account, the account holder owns the assets deposited with the bank. However, this is different with the escrow account. Here, the owner of the assets – also known as the trustor – and the account holder are not one and the same person. The latter is also known as the trustee.

The trustee manages the assets in the account and has sole power of disposal over the account. Nevertheless, the owner of the property does not lose his rights to it. A trust account is primarily used in the area of ​​construction or real estate financing; this type of money management is still used in the payment service area. The sense and purpose of the account is that the buyer does not yet completely lose influence on the purchase price and, in contrast, the seller does not yet fully receive this influence.

At the same time, however, there is security for him that the flow of money will take place as soon as the goods are handed over – or in the area of ​​real estate trading – a land charge is registered. Payment service providers use this type of account, among other things, to manage security deposits, so-called deposits.

If two parties have such an account set up, a corresponding contract is usually drawn up in advance. This stipulates, among other things, the duties of the trustee, how the assets are to be managed and whether remuneration is due. Both sides should be so comprehensively covered. If you are considering setting up an escrow account agreement, an attorney can provide advice.

What is escrow – define different forms of escrow

In looking at what is an escrow account, you should first be aware there are two different types of accounts: the hidden and the open.

In the case of a hidden account, it is not evident to the outside that there is an underlying trust relationship. Only the name of the account holder, i.e. the trustee, is mentioned in the name of the account. Hidden accounts have a number of drawbacks. The bank considers it a regular account and assumes that the existing assets belong to the trustee.

Furthermore, the bank is not liable if the trustee does not handle the money correctly. Another disadvantage can arise if the trustee files for bankruptcy. We will go into this in more detail later.

In contrast, an open account means that the trust relationship can be clearly identified. Both the name of the trustee and the trustor are noted in the name of the account. In addition, there is often information about the purpose for which the escrow account exists. As a special form of the open trust account, the account may only be opened by certain professional groups. This includes:

  • Notaries
  • Tax consultants
  • Lawyers
  • Auditors
  • Pastors

What is it used for?

Escrow in mortage

what is escrow

An escrow account is used in various transactions. One primary use that comes to mind is that such accounts can play an important role as real estate escrow when buying a property. So what is escrow in a mortgage used for? In this case, is used to secure payment processing and it is sometimes referred to as a notary trust account

However, it is only used in cases when the contracting parties have a justified security interest. This can be the case, for example, if the buyer finances the purchase price with several loans from different lenders.

What is escrow for mortgage procedure? The notary sets up an account for escrow mortgage and the buyer pays the agreed purchase price into it. The trustee only transfers the money to the seller when all the necessary requirements are met. As a rule, one of the requirements for escrow real estate procedures is that the buyer must first be entered in the land register as the new owner.

What is escrow balance in a mortgage?

An escrow balance is money in the account that is reserved to cover home insurance and taxes for you. In the USA, laws allow your lender to collect 1/6 of the annual tax and insurance payments at the signing of the property deal. After that, you deposit a further 1/12 of the annual tax and insurance payments every month when you make a mortgage payment. On your mortgage statement you will note there is an item titled ‘escrow’ that gives you the figure to add to the mortgage payment each month. You will have any leftover escrow balance refunded when you pay the loan off completely. Also read up on how to use mortgage points to lower your mortgage rate

Bankruptcy

Escrow accounts also play an important role in the event of bankruptcy. Often times, an escrow account is set up by an insolvency administrator. In this case it is always an open escrow account. Third-party payments do not go to the insolvency debtor’s private account, but to the trust account, then the escrow payment is made when needed.

Inheritance

Trust accounts can also be set up for inheritances – for example, if a minor inherits an amount of money, but the deceased has stipulated in his will that the amount should only be paid out when he reaches the age of majority. The money then stays in the escrow account until the heir is old enough. In the meantime, the trustor manages the assets until the person comes of age and then the trustor can make the escrow payment and close escrow.

However, escrow closing is sometimes not automatic, as the trustee may request to continue to have their affairs handled through the trustor, in which case closing escrow is deferred to after an agreed period of time

Rental and bond deposits

There is also an escrow account for the rental deposit. If you move into an apartment, the landlord usually requires a deposit. In the event of damage to the apartment or lack of rental payments, this amount serves as security. If the tenant moves out again, he gets the money back. The escrow account is a way of depositing the deposit. It is important that the landlord must invest the deposit with interest.

Debt counselling

Among other things, trust accounts can also be helpful if those affected are supported by debt counseling, for example. If over-indebted people need help with the administration of their financial resources to reduce debt, an employee of the advice center can take over the account management for a certain period of time.

The income is usually transferred to the escrow account and the trustee makes regular payments from it, for example for rent , installment payments, etc. Furthermore, a fixed amount is paid out to the person concerned at certain intervals, with which he has to finance his living. Through the counseling, the person concerned gradually learns how to handle his money correctly himself.

Funeral arrangements

Funerals are expensive. The costs are usually paid with the inheritance of the deceased. If the money is not enough, the relatives have to pay the costs themselves. If you want to protect your relatives from this financial burden, you should take appropriate precautions during your lifetime. Among other things, you have the option of storing money in an escrow account for the funeral. You can do this directly at the undertaker. However, you should make sure that the money is deposited with a trustee. Then the amount is safe even if the undertaker has to file for bankruptcy.

What are the costs?

Some banks offer a regular escrow account free of charge, while others charge corresponding account management fees. Before you decide on a bank, you should find out about any fees that may apply.

Please also note the following: There are additional costs for an escrow account , i.e. a special trust account. Here the so-called lifting charge is in fact due. If an escrow account is kept by a notary or a lawyer and he forwards funds, he is entitled to remuneration as a fee. How high this fee is depends on the amount of the transferred amount.

In addition, applicable taxes should not be forgotten. If someone other than the owner exercises actual control over an asset in such a way that, as a rule, he can economically exclude the owner from affecting the asset for the normal useful life, the asset is to be attributed to him. In the case of fiduciary relationships, the economic assets are to be assigned to the trustor, in the case of collateral property to the collateral provider and in the case of personal ownership to the owner.

This means that taxes on the escrow account have to be paid by the trustor. Finally, the assets in the account are added to his income. However, the trustee must ensure that taxes on the assets in the escrow account are paid correctly.

Is an escrow account insolvency proof?

Only a special escrow account is insolvency-proof. The question is often asked what happens to an escrow account if the trustee has to file for bankruptcy due to financial problems. In this case, does the trustor have to assume that his assets are in danger?

If it is an escrow account, the procedure in the event of bankruptcy is precisely regulated. According to the Insolvency Code, the credit balance on the special trust account is separated from the bankruptcy estate .

However, the situation is different with a regular escrow account . There is no legal protection here. So if the trustee goes bankrupt , the assets can flow into the bankruptcy estate. After all, he is listed as the account holder. In order to protect themselves, trustors should therefore contractually stipulate that the trustee must strictly separate his private assets and those of the other person .

Is it possible for an escrow account to be attached? Take, as an example, a hidden trust account held by a homeowners association. The administrator acts as a trustee. If he gets into financial difficulties, creditors can seize the account as he is the account holder. In this case, the trustor can often only ensure that the assets are released by means of a third party action. For this reason, those affected should contact a lawyer when attaching an escrow account. He can advise you on how to proceed.