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Real estate transactions have been tricky and concerning for both buyers and sellers since many years in India. Therefore the concept of escrow account was thought of being utilized in the real estate payments. This concept has benefited and relieved a lot of buyers and has proved to be a time saving check on the builder’s utilization of the money. Recently, the approved Real Estate Bill has also made it compulsory for builders to deposit 70% of the amount raised from buyers into an escrow account in a scheduled bank within a period of 15 days to cover the construction cost of the project for timely completion of the project.
This has proved as a beneficial move for customers as they can keep a track of the money usage and also make sure that the project progress matches with the expenses made.
What is an escrow account actually?
Escrow account is basically a temporary pass through account held by a third party. This account is created during the process of a transaction between two parties. Escrow account is therefore a temporary account as it is operational only until the completion of a transaction process. This is implemented after all the conditions between the buyer and the seller are settled with the consent of both the parties as part of the mutual agreement.
To describe it in context of real estate sector we can say that the fund flows for the development of the project from any source is kept in the escrow account and the funds utilized for the same are also generated from the escrow account. Even the buyers of the housing units in a project transfer the home price to the escrow account and the amount is not transferred to the seller until the project is completed successfully as agreed upon.
In these cases mostly the construction linked payments (CLP), a real estate payment scheme, are disbursed to the seller from the escrow account. This is done because the builder may claim not to have sufficient funds for the house and hence therefore funds are released from the escrow account to support the fund requirement for the completion of the project. Sellers also get benefitted from the prioritization mechanism, also called waterfall mechanism, wherein the priority based payments are made to the concerned parties.
To quote an example here, Mr. A as the buyer and Mr. B as the builder or the seller. Mr. A needs to buy a house which has to be built by Mr. B. Now Mr. A owes some money to Mr. B. In case of the escrow account provision Mr. A will deposit the money in a third party account which is managed by an escrow officer, Mr. C who is usually a lawyer or title company representative. He is the one who is holding all the important documents and deposits while the buyer and seller work out details. The escrow officer gets a 1% or 2% fee for managing the account and other details and making sure that the closing goes smoothly and both buyer and seller get what they owe to each other at the end of the deal.
Escrow account therefore, protects both the buyer and the seller in a transaction. It helps by ensuring that both parties perform according to the provisions of the deal.
Escrow account works at saving a lot of buyers from the unwanted delays happening because of some clever investments using their money in different projects without the knowledge of the buyer. This is the one of the biggest reasons for delay in real estate projects as this results in shortage of funds. The, to be known fact here is that, how does this shortage of fund happen. If you have opted for a down payment plan then the entire amount is supposed to go to the builder in no time, while in case of construction link plan a significant amount is given at once and rest is linked to construction. The bank disburse the money to builders keeping in mind the plan or the scheme opted by the buyer.
Now, this money is the property of the builder and he can use it however he likes. It can be used by him to service his debts, or can be invested in different projects which are more in demand, or for paying taxes etc. This adds to the delay to your project.
Therefore, to be saved from such clever moves and escrow account helps a lot.
How does an escrow account help?
An escrow account is mandatory for timely and proper release of funds without any hurdles.The escrow officer or the trustee as explained earlier has well-defined instructions on release of funds. He is responsible for enforcing a charge on assets, managing the covenants and with approval, effecting the remedies against default. The escrow officer has the duty to see that the builder does not uses the funds parked in his account for a purpose not coinciding with the project goal.
The use of escrow mechanism is a confidential agreement between the lender and the borrower. It has been made compulsory in RERA also that the builder cannot refuse to open it. To have an escrow account is definitely not a mandate but when it comes to being saved from fraud and unwanted delays this is something which can be definitely considered and opted.