Escrow funds are money set aside in a special escrow account as a deposit on a given sale or transaction. There are two major situations in which escrow is required: in an auction purchase or in a sale of land. The purpose of an escrow account is to keep money safe and secure until a given event takes place and to act as a guarantee to the seller of an item that the buyer is actually interested in and capable of purchasing the item.
In real estate, a person makes an offer on a piece of property, usually either a plot of land or an existing home or building. The individual who makes the offer normally makes it contingent on a number of factors. The contingencies can include an inspection of the structure or property, a title search to ensure that the property has a free and clear title, and the buyer's ability to receive permits or financing. When a buyer makes this contingent offer, if the seller accepts, he must take the property off the market while the buyer ensures the land meets his needs.
In order for the seller to take the property off the market, he must know that the buyer has the funds to pay the money and that the buyer is serious about following through on the offer. As a result, a deposit or earnest money is often required. That money is considered escrow funds, since it is money the buyer will pay to the seller if the buyer does not follow through on his part of the deal. The escrow funds are kept in a special account, usually at the real estate office, and when the deal closes, the escrow funds are paid to the seller. If the deal does not close because one or more of the contingencies in the contract are not met, then the escrow funds are returned to the buyer.
A similar premise exists in auctions. A person buying an item at auction may wish to have the item appraised or the authenticity determined before he follows through on the deal. The buyer will pay a deposit that is put into escrow with a third party. Upon the conditions being fulfilled — i.e. the item being determined authentic — the escrow money is then paid to the seller.