A widely used instrument in real estate transactions, the escrow deposit is a sum of money the buyer pays to guarantee the purchase offer submitted. And, more importantly, their intention to complete the transaction. The amount is deposited with a neutral third party, such as a notary or real estate agency. It is not released to the seller until the offer is accepted or the preliminary contract is signed. Upon signing, it becomes a confirmatory deposit.
What is meant by escrow?
In the real estate sector, a trust deposit is an agreement through which a real estate agency or notary—officially a third party between the seller and the potential buyer—receives and holds a sum of money or relevant documents on behalf of the parties involved in the sale or rental transaction. The trust is concluded when the parties finalise the agreement.
Establishing an escrow is a kind of guarantee: the parties agree not to access the deposited amount until the deal is successfully closed, providing protection for compliance with the agreements made.
This is a practice that, after the property appraisal and the negotiations leading to the sale or rental, truly protects the parties.
- The buyer is assured that payment will be made to the seller once the contractual terms are met (this also includes any property inspections and obtaining financing).
- The seller receives confirmation that the buyer is truly committed to completing the sale and, above all, is certain that the funds will be available once the various formalities have been completed.
What is an escrow agreement?
Escrow transactions are managed through a specific contract, whereby one party—the depositor—entrusts assets to a third party—the trustee—for safekeeping. The amount in question must be returned when certain conditions are met.
In this context, a very important role is played by the trustee, a neutral and reliable third party who manages the funds throughout the various negotiations. This person could be a notary, a real estate agency, a financial institution, or any other entity specialised in providing this specific service.
The trustee's role is to ensure security: they must ensure that the terms of the agreement are respected. Only when this is achieved can they officially release the funds.
What are the main steps?
There are four steps that characterise the escrow:
- The initial agreement is signed: the buyer and seller decide to use the escrow instrument. The terms and conditions are defined;
- The funds or assets are transferred: at this point, the potential buyer deposits the money with the trustee;
- The conditions are met. The trustee's task, at this point, is to verify that the clauses established by the sales agreement are respected;
- Funds are released: Once all conditions have been met, the trustee transfers the funds to the beneficiary.
What types of trust funds are there?
The legislation currently in force provides for two different types of escrow deposit:
- Interest-bearing, thanks to which, during the period of custody of the funds, interest is accrued, which can be allocated to one of the parties to the contract;
- Interest-free: the deposited money does not earn interest. This is the most common option, often adopted in real estate transactions. The sole objective is the security of the transaction.
Confirmatory deposit and advance payment: the differences
In real estate transactions, there are three different institutions, each with different purposes and characteristics. In addition to the escrow deposit, there are the confirmatory deposit and the down payment.
Regulated by Article 1385 of the Civil Code, the confirmatory deposit is essentially a sum paid by the buyer as a guarantee of the commitment they have made. If the buyer fails to fulfil the contract, the seller has the right to retain the deposit as compensation. If, however, the seller withdraws from the agreement, they are required to return double the amount received.
This is a tool that can guarantee minimal protection for compliance with the agreements signed by the parties. However, it does present a risk as the funds flow immediately into the seller's hands. There are no further guarantees.
What is the advance?
As its name suggests, an advance payment is essentially a partial payment of the price agreed upon by the parties. It provides no legal guarantee: if the transaction is not completed, it can be returned or retained based on the objective responsibilities that led to the cancellation of the agreement.
It is used when sales are made for properties under construction. In the event of disputes, it may be necessary to initiate legal action to recover the amount paid.
The safest choice
Generally, among the options available to the parties, escrow is the safest and most reliable choice.
Choosing a third party—which could be a real estate agency, a notary, or another entity—makes the transaction completely neutral: the funds remain in the trustee's hands until the purchase and sale agreements are finalised. The escrow, in other words, reduces risks for both parties, protecting them from potential disputes.
Moreover, it is a particularly flexible instrument, which can be used for slightly more complex transactions with a high value, rather than for simpler ones.
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