Escrow account – financial protection for property buyers

Before the Developer Act was introduced, buying a flat on the primary market carried considerable risk. There are known cases of developers who went bankrupt. Clients who had paid deposits towards properties under construction found themselves in an exceptionally difficult situation. Find out what an escrow account is and how it works in your favour.

A developer's escrow account – what is it?

An escrow account is a type of bank account that every developer is required to maintain. Clients' funds for the purchase of a property that is still under construction are paid into it. The bank oversees the funds accumulated there and it is the bank that decides whether to release them to the account holder. For that to happen, the developer must meet certain conditions.

This way of settling payments with developers is regulated by the Act of 16 September 2011 on the protection of the rights of buyers of residential premises or single-family houses. It is commonly called the Developer Act, because its purpose is to protect the interests of clients of companies offering primary-market properties.

Under the regulations, every developer who runs a construction project and plans to start selling flats must open an escrow account. So if you are looking for a new house in Silesia, make sure that the seller you sign the contract with operates in accordance with the law.

The escrow account and the Developer Act

The obligation for a developer to open an escrow account is intended to safeguard the interests of such companies' clients. Thanks to the Developer Act, people buying a flat are not at risk of losing the money they have paid if the seller goes bankrupt.

There are many known situations in which clients were left "without a roof over their heads" and lost the savings they had paid towards flats under construction. In some cases the construction never started at all, and most often it was halted at a stage that made it impossible to move into the buildings being erected.

Under the so-called Developer Act, the bank watches over the funds paid in, so there is no risk that they will be lost.

Types of escrow accounts

Developers can use one of four types of escrow account. They are as follows:

• closed escrow account,
• open escrow account + insurance guarantee,
• open escrow account + bank guarantee,
• open escrow account without additional guarantees.

Open escrow accounts together with bank or insurance guarantees are the most advantageous for clients. They provide additional protection if the developer fails to perform the contract or if the buyer withdraws from the contract through the developer's fault.

Open and closed escrow accounts – what is the difference?

The most common are closed escrow accounts and standard open ones (without additional safeguards).

Open escrow account

An open account is closely tied to the schedule of works on the construction project. This means that the developer can withdraw money from the account only once it proves that a given stage of the project has been completed. The size of the instalments paid out by the bank is also important. Under the regulations, they may not be lower than 10% or higher than 25% of the value of the property.

Closed escrow account

A closed escrow account, on the other hand, is a better safeguard for the developer's clients. The account holder can withdraw money from it only when the entire project has been completed. If the bank terminates its agreement with the developer, the developer must immediately transfer the account to another institution in order to continue selling flats.

Closed escrow accounts are less popular with development companies. They are also not always cost-effective for their clients. The company has to finance the construction from its own funds, which often results in a much higher purchase price for the property.

The obligation to maintain escrow accounts of every type gives property buyers a sense of security and clearly works in their favour.