Earnest Money in Colorado Real Estate
Earnest money is a deposit of money that is later put toward the balance in the purchase of real estate. In Colorado real estate transactions, the term can be taken quite literally. It is “money” that proves that the buyer’s offer to buy someone’s property is made in “earnest.”
The buyer gives funds in order to show that they mean to follow through with the offer they are making. If either side breaches the Contract to Buy and Sell Real Estate, the other side gets to keep the earnest money.
Situations vary, but a bottom line that can be drawn is that earnest money is there to keep people acting with honestly and in good faith.
The processes used to protect that money are not quite so simple, and are another outstanding reason that I believe it is in people’s best interest to use a licensed real estate agent, and even better, a Colorado Realtor®, when buying or selling property in Colorado, and everywhere else in America.
Earnest money deposit amounts are usually detailed in the Multiple Listing Service property details.
As shown here, the Earnest Money for this property is $4,000. The check (in this example case) would be made to RE/MAX Alliance. It would be cashed to make sure that the check clears and that the funds are real.
That money is then held in a trust account, and the way those funds are held are subject to rules governing real estate in Colorado.
According to Van Education Center, a company that educates potential real estate agents to prepare for their state and national tests:
When a broker receives money belonging to others, it needs to be deposited into one or more trust (escrow) accounts separate from other money belonging to the broker or the brokerage company. Trust accounts are established by having a deposit agreement with a Colorado depository that offers FDIC insurance coverage.The fiduciary nature of the account must be identified. The Federal Deposit Insurance Corporation (FDIC) provides “dollar-for-dollar” insurance coverage for money held in all accounts maintained by a specific depositor-beneficiary at an insured bank up to a maximum amount of $250,000 per person.
Different trust accounts exist for different classes of beneficiaries. Funds belonging to the same “common class” of beneficiaries are normally deposited into a “pooled” escrow bank account, unless otherwise prohibited by other law or agreement between the parties concerned. The following list demonstrates the types of trust or escrow accounts based on different possible classes of beneficiaries.
Different classes include, but are not limited to; Buyers, investors, tenants, HOA’s and Partnership Members. There are varying rules for brokerages that handle mostly sales, but have some property management. In some cases, they can use the same trust account for both real estate sales and property management. But, if the brokerage handles over a certain number of properties that they manage that aren’t for sale, they must establish separate accounts for each.
There are scores of rules and regulations that anyone who handles earnest money deposits must follow, and this is the state’s way of using licensed agents and real estate brokers to protect the public. This part of the transaction deals with liquid money before closing, so a lot of different people have vested interests in keeping things above board.
Legal processes and issues aside, earnest money is given to show that the buyer is serious, that the offer is genuine, and that everyone wants to move forward with the sale of the property in question.
Earnest money deposits must be transparent and trackable. As you’ll learn if you go into buying and selling real estate in any depth, earnest money is one of the main things that keeps people honest.
In Colorado real estate, when using a Realtor® or licensed agent, if anyone acts in bad faith, the main recourse is that the party who was wronged gets to keep the earnest money deposit. Either the buyer gets it back, if, for example, a seller decides they no longer want to sell and terminate the contract. Or, the seller gets to keep the earnest money, if, for example, the buyer decides they no longer want to buy, and pull out of the deal in a way that breaches the Contract to Buy and Sell Real Estate (see copy of Contract here).
It is my opinion that Colorado state contracts favor the buyer. In fact, the current contract we use gives the buyer five different opportunities to cancel the deal throughout the due diligence period. The buyer may terminate by the dates of; inspection, appraisal, insurance, HOA and loan approval. These points are detailed in the “Dates and Deadlines” section of the contract. Buyer has until such and such a date to have the home inspected. If, after inspection, they decide there is a problem they don’t want to deal with, they can cancel and get their earnest money back.
They have to terminate within the dates they’ve chosen. As long as it is before the “Inspection Resolution Deadline”, the buyer can terminate because of something they found in inspection and have their earnest money returned, and there really isn’t much that the seller can do about it. In fact, the term “sole, subjective discretion” is used when referring to reasons why buyers may terminate a contract with regards to all the due diligence matters that exist in the contract. It’s a powerful position for the buyer, and that is why I believe the state contract favors the buyer.
Earnest Money Disputes
Section 23 of the Contract to Buy and Sell Real Estate states, among other things, the following:
23. MEDIATION. If a dispute arises relating to this Contract, (whether prior to or after Closing) and is not resolved, the parties must first proceed, in good faith, to mediation. Source – Contract to Buy and Sell Real Estate
The first step in most earnest money disputes is for the parties, most usually through their agents, to try to work it out and have everyone agree on and sign an Earnest Money release. This is done, usually, through meetings, phone calls, pondering and compromise. Sometimes, one party has to admit that they should let it go and give up the earnest money to the other party. It’s a tense situation, and the Contract usually guides the way.
However, if an agreement cannot be reached, both parties, if they’ve entered into the Contract to Buy and Sell Real Estate, have agreed to go to mediation before any arbitration or litigation. Both parties share the cost of mediation. This provision is probably included because by the time people start suing and hiring lawyers, everyone has already lost. Mediation is less costly, and even though a couple thousand dollars is nothing to sneeze at, it’s probably going to be less than a legal battle of any size or scope.
Does Earnest Money Come From My Loan?
No. In most cases, the earnest money is put directly toward the down payment/balance of the loan, but it is not funded by the loan. It needs to be cash equivalent. Real money. The check will be cashed. It’s one of the upfront costs of buying real estate, in almost every case.