What Does Commingling in Real Estate Mean?
What Does Commingling in Real Estate Mean?
As a real estate agent, you are legally responsible for managing your client's funds throughout the transaction process.
That’s why agents and their clients have a fiduciary relationship, and agents have a legal obligation to handle clients’ funds properly.
Commingling is a term you’ll likely see on your real estate exam and is an example of mismanaging your client's money in the real estate transaction.
If you’re unfamiliar, make sure you take the time to learn what commingling is and how you can avoid it.
What is Commingling?
Real estate commingling is the act of mixing the client’s funds with the broker’s own funds. This is illegal and happens when a broker or real estate agent fails to properly deposit their client's funds into an escrow account, client trust, or earnest money account within the mandated time frame.
The mixing of funds like this should be avoided at all costs and is considered a type of fraud. It can have serious legal consequences like having your license suspended or revoked.
There are a few legal ways to commingle money regarding real estate investing. This occurs when funds are used intentionally from multiple sources.
For example, individual investors contribute to a real estate investment trust (REIT) or participate in a crowdfunding project. Commingling is allowed when the money is intentionally being invested in real estate. But when it comes to the broker and agent relationship, it is not legal.
Why is Commingling Illegal in Real Estate?
Commingling occurs when the client’s money is not handled correctly and is mixed with the broker’s funds. While each state differs, mixing funds between a broker and their clients is usually illegal.
This is because most brokers and agents must follow a set of fiduciary duties and are bound to a different set of codes that they must follow.
While acting as the fiduciary, they must manage their client’s funds according to the law and real state code.
While commingling is the mixing of funds, conversion refers to spending a client's money for something other than what it was intended for.
When funds are commingled, it is not uncommon for conversion to also occur. Conversion is also a type of theft punishable by law.
If commingling and subsequent conversion occur, agents could be found in breach of their fiduciary responsibility and lose their license. It is a type of fraud, and agents should follow all proper steps to avoid this.
How Can You Avoid Commingling Funds?
To avoid commingling funds, it is best to keep separate bank accounts for your business or investment accounts and your personal funds.
This way, there is a minimized chance you would accidentally spend your client or investment money on personal expenses.
There are several simple ways you can avoid commingling funds.
- Follow the proper escrow process when transacting with clients
- Set up an LLC for your investment properties
- Create a trust account to hold security deposits
- Keep meticulous records to track all your transactions.
- Invest in appropriate bookkeeping software to ensure all transactions are categorized as business-related can be accounted for
- Have a system of checks and balances to ensure funds are deposited correctly
- Educate your team on the best way to collect client funds
- When in doubt, ask for legal advice from your broker or a real estate lawyer
How is Money Transferred to All Parties in a Real Estate Transaction?
To avoid the commingling of funds in real estate transactions, a third party will hold the funds until the contract terms are fulfilled.
Keeping the funds in a third-party account is called escrow, and there are multiple types of escrow accounts a buyer or seller will encounter during the process.
The main goal of having an escrow bank account is to keep the client’s money separate and prevent funds from being mixed with other clients or the broker’s own funds.
When a client is ready to make an offer on a property, the real estate agents will collect the earnest money deposit and transfer it to an escrow account until the deal has closed.
The earnest money deposit is usually collected within five days of submitting the offer and is held in the escrow account until closing day.
The escrow process usually lasts 30 days and is considered complete when all financing and inspections have been approved and the property is ready for closing.
At settlement, the buyer will have to submit a cashier’s check or submit a wire transfer of the down payment and closing costs. Once this has been completed, escrow can be closed.
The escrow agent is then responsible for disbursing the funds to the appropriate parties at settlement.
After closing on a property, it is common to have a mortgage escrow. This is different from an earnest money deposit and allows the lender to collect extra funds along with the mortgage payment.
Often these will go into a fund to pay for things like property taxes and insurance premiums on behalf of the homeowner.
Final Thoughts on Commingling in Real Estate
Commingling can be a complicated topic. Agents should be aware of the consequences of combining funds and should take all steps to follow the proper escrow procedure.
Talk to your real estate broker or a lawyer to confirm if you’re ever unsure of the proper way to deposit or handle your client's funds.
Your real estate exam will cover in-depth your fiduciary relationship with clients. Make sure you take the time to study commingling for your real estate exam.
You’ll stay informed and ensure you handle your client’s funds the right way, every time.
TL;DR: Commingling is when a real estate agent or broker mixes their client's funds with their own. For example, putting the client's deposit into their own bank account with the intention of transferring it to escrow later.