Real Estate Earnest Money

Unit 8: Earnest Money Earnest money, also known as trust account money, is a deposit, usually made in the form of a check, to show evidence of the buyer's intention to carry out the terms of the contract in good faith. Even though a check is most common, an earnest deposit can be taken in any form. Cash, check, personal property, a boat, or a diamond ring would be examples of possible earnest deposits that a purchaser might use. The key issue here is notification to the seller of the form of the deposit. The seller must agree and understand that the deposit was in the form of "a diamond bracelet." Earnest money is provided when the offer to purchase real estate is made. The amount of the earnest money deposit is something the parties should agree upon, and the amount generally varies with the value of the property being purchased. Many contracts state that this deposit becomes the seller's property if the buyer defaults, but this depends on the specifics of each contract. Note: An earnest money deposit is not required for a contract to be valid. However, many real estate licensees are instructed by their sponsoring brokers to advise clients of the risks that may be involved if they accept a contract with no earnest money given. Unit 8: Definition of Escrow Moneys Important Note: The handling of trust account funds is dictated by the license law and differs from stateto-state. You will learn the trust account laws for your state when you take the license law portion of this course. Please be advised that the information covered in this unit is generic and may differ a bit from your own state. Many states define escrow moneys as all moneys, promissory notes or any other type or manner of legal tender or financial consideration deposited with any person for the benefit of the parties to the transaction. A transaction exists once an accepted real estate contract is signed or a lease agreed to by the parties. Escrow moneys include, without limitation, earnest moneys and security deposits, except those security deposits in which the person holding the security deposit is also the sole owner of the property being leased or sold and for which the security deposit is being held. Earnest money constitutes escrow moneys and, as we said, it may be in the form of not only personal checks, but also cashier's checks, money orders, cash, or any other forms of legal tender. Under the terms of a written agreement between a licensee and a client, certain money does NOT fall under the heading of "escrow moneys." An example of this would be rent money paid to a licensee for transmittal to the licensee's client (the owner) in a property management agreement. Unit 8: Maintaining an Escrow Account Sponsoring brokers responsible for earnest money must establish an escrow account, which is a special account, separate and apart from personal or other business accounts, that contains all escrow moneys entrusted to them while acting as the real estate brokers or escrow agents for others. In most states, the rules regarding escrow accounts include the following: An escrow account must be non-interest bearing, unless the parties to the transaction specifically require, in writing, that the deposit be placed in an interest-bearing account, OR if the deposit is required by law to accrue interest. If an interest-bearing account is required, the sponsoring broker must indicate in writing who will be receiving the interest from the account. A sponsoring broker may maintain more than one escrow account, but it IS NOT NECESSARY to open a special escrow account for EACH earnest money deposit received. A sponsoring broker who does NOT receive escrow moneys entrusted to him as a real estate broker (or other temporary custodian of funds of others entrusted to him) does NOT need to maintain an escrow account. ALL escrow accounts, whether interest-bearing or non-interest bearing, must be maintained at a federally-insured depository. The sponsoring broker must issue a receipt to the payor for any escrow monies and keep a copy with the transaction records. Unit 8: Rules Regarding Escrow Accounts The following rules also apply to escrow funds in many states: Commingling is an ILLEGAL act in which a real estate licensee places client or customer funds with his or her own personal funds. Commingling of a licensee's business and personal funds is prohibited. However, a sponsoring broker may deposit from his or her own personal funds, and keep in any escrow account, enough money to avoid incurring service charges relating to the escrow account. The sponsoring broker must specifically document those funds as being for service charges and he or she must have proof available that the amount of his or her own funds in the escrow account does not exceed the minimum amount required by the depository to maintain the account without incurring service charges. All licensees should give earnest money checks to their sponsoring broker immediately (unless your state license law says otherwise). Generally, earnest money received by the broker must be deposited before a stipulated deadline established by state regulation or statute. A sponsoring broker who is also serving as an escrow agent must notify all principals in writing if or when one of these situations occurs: A principal fails to tender escrow moneys. A principal's payment as escrow moneys is dishonored by the financial institution on which it was drawn There appears on the face of the governing contract to be a deficiency in the amount on deposit Sponsoring brokers must always be able to account for any client or escrow funds, as well as important documents. Unit 8: Disbursing Escrow Funds The sponsoring broker must keep all escrow moneys on deposit in an escrow account until a transaction is consummated or terminated. Escrow moneys must be disbursed according to the requirements stated below. However, in all cases, the moneys may NOT be disbursed until the funds have been honored by the payor's financial depository. When a transaction has consummated or terminated, the sponsoring broker must disburse the funds according to the terms of the contract. He or she must make the disbursement No earlier than the day the transaction is consummated or terminated and Not later than the next business day after the transaction is consummated or terminated, unless the broker has received other written direction from all principals to the transaction or their duly authorized agents. If applicable, the sponsoring broker will disburse any commissions and/or fees he or she has earned in the transaction from the funds deposited in an escrow account: No earlier than the day the transaction is consummated or terminated and Not later than the next business day after the transaction is consummated or terminated, unless the broker has received other written direction from all principals to the transaction or their duly authorized agents. Unit 8: Disbursing Escrow Funds An authorized disbursement is one which is made on behalf of, and at the written direction of, all principals to the transaction or their duly authorized agents. A sponsoring broker must never withhold, for any period of time, an authorized disbursement of escrow moneys due to any claim for a commission or compensation to any licensee. Note: Only the sponsoring broker or authorized agent is permitted to withdraw funds from the escrow account. Other Disbursement Situations Keep in mind that other disbursement schedules are possible. If prior to the consummation or termination of the transaction, the sponsoring broker receives written direction from all of the principals to the transaction (or their duly authorized agents) agreeing to a disbursement of the escrow moneys, that broker must disburse the escrow moneys according to those written directions. Such disbursement must be made not later than the next business day following the sponsoring broker's receipt of the last required written direction. Unit 8: Other Disbursement Situations Other disbursement situations include: The sponsoring broker may release escrow moneys prior to the consummation or termination of the transaction in accordance with directions providing for the release, payment, or distribution of escrow moneys contained in any written contract signed by the principals to the transaction (or their duly authorized agents). In any such case the sponsoring broker must adhere to the terms of the contract regarding the release of the escrow moneys. If the sponsoring broker receives an order from a court of competent jurisdiction providing for the disbursement of the escrow moneys, that broker must disburse the escrow moneys according to the terms of the order. Sometimes the earnest money check is from someone other than the party to the contract. In that instance, when earnest money is returned, it must be returned to the party in the contract. For example: The buyer's parents write the earnest money check. The earnest money would be returned to the buyers, not to the parents. Unit 8: Escrow Money Disputes If any disputes between parties arise regarding escrow money, the sponsoring broker should continue to "hold" the money until one of the following takes place: The sponsoring broker receives a written release from both parties or both parties' duly authorized agents (power of attorney or attorney at law). The disbursement must be according to the terms of the written directions and take place not later than the next business day following the sponsoring broker's receipt of the required written release. An interpleader action is filed. After a civil action is filed by either the sponsoring broker or one of the parties, the courts will determine the disposition of the funds, at which time payment may be made to the court. Note: If an interpleader action is filed by the sponsoring broker, and the broker is so authorized by the real estate contract, he or she may withdraw from the escrow account the amount of money needed to reimburse the sponsoring broker for costs and reasonable attorney's fees associated with that action. This does NOT include any costs and attorney's fees associated with that broker's attempt to collect a commission or fee. The funds are turned over to the State Treasurer and become unclaimed property due to inactivity of the account, inability to locate the parties, or inability of the parties to reach a resolution. Funds become "unclaimed" in either of these circumstances: Five years have passed. Six months have elapsed since the sponsoring broker has received a written demand from one of the principals or the principal's authorized agent. Unit 8: Check Your Understanding Answers What forms can an earnest money deposit take? Personal checks, cashier's checks, money orders, cash, or any other forms of legal tender What type of account must an escrow account be and where must it be maintained? An escrow account must be non-interest bearing and must be maintained at a federally-insured depository. In most cases, when must earnest money be deposited? By the next business day after contract acceptance. When a transaction has consummated or terminated, when and how must the sponsoring broker disburse the funds? The sponsoring broker must disburse the funds according to the terms of the contract. He or she must make the disbursement no earlier than the day the transaction is consummated or terminated and not later than the next business day after the transaction is consummated or terminated, unless the broker has received other written direction from all principals to the transaction or their duly authorized agents. Unit 8: Escrow Records Each sponsoring broker who accepts earnest money must maintain a bookkeeping system that complies with sound accounting principles. The sponsoring broker must keep the system in his or her office or place of business. (Check your own state rules for the specifics of the recordkeeping required by your state.) In most cases, the system must consist of at least the following escrow records: Master escrow account log Journal Ledger Monthly reconciliation statements Let's look at each of these in more detail. Master Escrow Account Log Each sponsoring broker must keep a master escrow account log identifying all escrow bank account numbers and the name and address of the bank where the escrow accounts are located. This log must specifically include all bank account numbers opened for individual transactions, even if those account numbers fall under another umbrella account number. Unit 8: Escrow Records- Journal Journal The sponsoring broker must keep a journal for each escrow account. This journal must show the chronological sequence in which funds are received and disbursed by the sponsoring broker. For funds received, the journal must include the date the funds were received, the name of the person on whose behalf the funds are delivered to that broker, and the amount of money received. For funds disbursed, the journal must include the date, the payee, the check number, and the amount disbursed. Every entry must show the running balance after each receipt or disbursement. Unit 8: Escrow Records - Ledger Ledger The sponsoring broker will maintain a ledger for each transaction. The ledger will: Show the receipt and the disbursement of funds affecting a single particular transaction such as between buyer and seller, or landlord and tenant, or the respective parties to any other relationship. Include the names of all parties to a transaction, the amount of funds the sponsoring broker received, and the date the broker received the funds. Show the date of disbursement, the payee, the check number, and the amount disbursed, when funds are disbursed. Segregate one transaction from another transaction. The sponsoring broker will keep a separate ledger or a separate section of each ledger (as he or she chooses) for each of the various kinds of real estate transactions, such as leases and sales. If the ledger is computer generated from the same data entry from which the journal is generated, the sponsoring broker must maintain copies of the bank deposit slips, bank disbursement slips, or other bank receipts, to account for the data on the ledger. Unit 8: Escrow Records - Monthly Reconciliation Statement Monthly Reconciliation Statement State law usually requires the sponsoring broker to reconcile each escrow account that he or she maintains within some specified number of days after he or she receives the monthly bank statement. This rule does not typically apply if there has been no transactional activity during the previous month. The reconciliation should include a written work sheet which compares the balances shown on the bank statement, the journal, and the ledger respectively. The comparison is necessary to insure agreement between the actual escrow account and the broker's journal and ledger entries. The sponsoring broker must keep the documentation of the reconciliation for a specified number of years (usually 3-5 years) from the last day of the month covered by that reconciliation. Unit 8: Other Rules Regarding Escrow Records Other rules that may apply to escrow records include the following: If a sponsoring broker transfers escrow moneys from an escrow account to another account for disbursement, he or she must keep a copy of all records reflecting the disbursement from the other account. A sponsoring broker may choose to use a more sophisticated bookkeeping system based on sound accounting principles, including a system of electronic data processing equipment. However, if the broker chooses an alternate system, that system must contain or produce printed records that have all the information required by that state's laws. Most states require that the broker make available to the real estate licensing agency all escrow records and related documents that he or she maintained in connection with the practice of real estate. These records must be available during normal business hours and usually must be submitted within 24 hours after a request. Unit 8: Rules Regarding Escrow Records Additional rules that apply to escrow records may include the following: Except as otherwise provided by law, the broker must keep copies of all escrow money instruments received from a principal as part of a transaction. This includes copies of all personal checks, cashier's checks, certified checks, money orders, promissory notes, or other financial instruments. The broker must also maintain copies and/or documentation of all disbursements or transfers into or out of an escrow account. A sponsoring broker must keep all escrow records for 3-5 years. In many cases, the state will require that the broker keep the escrow records for the immediate prior 2 years in the office location. However, he or she can keep the balance of the records at another location. If escrow records are lost, stolen, or destroyed due to fire, flood or any other circumstances, the sponsoring broker must report the loss to their state licensing agency within some specified period of time. The broker must also obtain copies of monthly bank statements, deposit and disbursement receipts, and any other available records, so he or she can reconstruct the lost escrow records. Unit 8: Check Your Understanding Answers What is a master escrow account log? A log identifying all escrow bank account numbers and the name and address of the bank where the escrow accounts are located. What does a journal show? The chronological sequence in which funds are received and disbursed by the broker In most cases, for how long does the broker need to keep escrow records? Three to five years What should a broker do if escrow records are stolen, lost, or destroyed? Report the loss to their state licensing agency and then obtain copies of monthly bank statements, deposit and disbursement receipts, and any other available records, so he or she can reconstruct the lost escrow records.