Very cheap, reasonably clean, extremely friendly, and well located, the Posada is a good budget accomodation. The rooms are centered around a sunny courtyard, where a light breakfast is served each morning. The rooms were about $20 - $25 for one night, with bathroom. Single rooms will most likely be bunk beds with TV. Double rooms will either be bunks or double beds. The bathrooms are ok - just like other bathrooms in the area, the shower has a flat stone floor and a drain in the middle. My room was very quiet - although there's hardly any traffic in Colonia anyway. If you're traveling light and cheap, this is a great place to stay.
The Posada del Rio is right on the edge of the old city, and a ten to fifteen minute walk from the hydrofoils to Buenos Aires. (The town is very small and compact, so virtually everything is in walking distance). There are regular buses to Montevideo and points beyond as well.