Escrow services minimize transaction risks for all parties. Rather than the buyer simply paying the seller, the funds are placed into an escrow account, which is in the control of a neutral third party, explains The Balance. This neutral third party then supervises the transaction. Once all duties required by the sales contract are fulfilled, the third party releases the funds to the seller. Should obligations not be fulfilled, the sale is cancelled and the funds returned to the buyer.
When buyers and sellers agree to a transaction, they form a contract, whether that contract is written formally or verbally agreed upon. The contract always involves a monetary price for specified goods. In more complex transactions, the contract also involves additional actions that both parties must perform for the sale to be finalized.
Real estate transactions are the most common example of complex transactions that use escrow. Generally, the buyer must place earnest money into an escrow account in order for the seller to remove the property from the market. A sales contract is signed. If buyers fulfill all of their contractual obligations, the earnest money is applied to the sales price. If buyers refuse to complete their obligations, their earnest money is forfeited to the seller in compensation for the time the property was off the market. The buyer is also protected from an unscrupulous seller, who without escrow might cancel the sale and keep the earnest money.
Online purchases often use an escrow process for much less complex transactions. There may be no formal sales contract. The buyer and seller simply agreed that the seller would deliver the goods in exchange for a price. Since the buyer and seller are often unknown to each other, how are they to trust one another?
Using an escrow service provides the solution. The buyer places funds in the escrow account. The seller is then comfortable shipping the goods. This protects buyers from scam artists who could abscond with their funds and never send the product. It also protects sellers from dishonest buyers who receive the product and then never send payment.
Escrow accounts are often used for ongoing obligations, such as payment of property taxes. Mortgage companies require mortgagees to pay a share of their annual property tax into an escrow account each month, generally as part of their monthly mortgage payment. This protects the bank and the borrower against the borrower defaulting on the taxes, in which case the taxing authority would seize the property. Such an action would cause substantial financial losses for both the bank and borrower.