Escrow comes into the equation when a buyer and seller come to an agreement on a particular transaction. The buyer of the asset transfers some portion of the purchase price to an independent, third-party escrow account. The third party releases the funds to the seller if and only if all the conditions of agreement are met. An escrow holdback is a tool used in many financial transactions, especially real estate sales, to provide extra security assurances for all parties entering into the contract.
What is the Purpose of Escrow Holdback?
Escrow holdbacks ensure the seller of the asset that the buyer is serious and has the money to complete the deal. If the buyer backs out of the deal, he forfeits the money in the escrow account. Similarly, an escrow holdback allows the buyer to lock in the deal at a given price and at a given time. If the seller fails to come through on some portion of the agreement, the buyer can get his money back.
What is a Repair Escrow Example?
One of the most common uses of escrow holdback is in real estate transactions involving a repair. Suppose that Mr. Smith wants to buy a house from Mr. Jones, but the roof of Jones' house is badly damaged. Smith and Jones might negotiate a deal wherein Jones completes the repairs required on the roof and Smith pays a bit extra to complete the deal.
In this example, Smith would transfer money into an escrow account. Assuming Jones completes the repairs on his house in the allotted time frame, Jones would collect the escrow holdback amount and transfer the deed. If Jones failed to complete the repairs, however, Smith would get his money back. By the same token, escrow gives Jones confidence that Smith is a real buyer and that it's worth it to repair the roof. If Smith changes his mind after the roof is fixed, Jones keeps the money.
What is a Construction Holdback?
Besides repairs, escrow agreements are common in cases of new home construction. A family interested in a buying a home from a developer might place money in a holdback account pending completion of construction. The escrow account locks in the deal for both the developer and the family, but if the construction work is not up to standard, the family can receive a refund.
What are Some Other Uses of Escrow Holdbacks?
Beyond real estate deals, escrow holdback arrangements also are common in mergers and acquisitions in the business world. The buying company often transfers funds to an escrow account while it performs due diligence. This demonstrates that it is serious about making a deal and incentivizes the target company to open its books, but it also provides a means to recover the money if the data uncovered doesn't reconcile with the acquisition target's original claims.
- Escrow.com: How Does An Escrow Account Work?
- Quicken Loans: What Is an Escrow Holdback?
- Consumer Financial Protection Bureau. "§ 1024.17 Escrow Accounts." Accessed Sept. 13, 2020.
- North Carolina Real Estate Commission. "Questions and Answers on: Earnest Money Deposits." Accessed Sept. 13, 2020.
- South Carolina Association of CPAs. "SCDOR’s Online State Tax Lien Registry Launches on Nov. 1." Accessed Sept. 13, 2020.
Nick Robinson is a writer, instructor and graduate student. Before deciding to pursue an advanced degree, he worked as a teacher and administrator at three different colleges and universities, and as an education coach for Inside Track. Most of Robinson's writing centers on education and travel.