1. Washington Real Estate Fundamentals
Lesson 13:
Closing Real Estate Transactions
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2. Closing Real Estate Transactions
Closing: Final stage in a real estate transaction; also called settlement.
Buyer pays seller purchase price.
Seller transfers title to buyer.
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3. Escrow In Washington, closing process usually handled through escrow.
Escrow: Arrangement in which neutral third party holds money and documents for buyer and seller until transaction ready to close.
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4. Escrow Appointment of escrow agent
Escrow agent: Neutral third party selected to handle closing; also called closing agent.
Chosen by agreement between buyer and seller.
Often appointed in purchase agreement.
Acts as dual agent.
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5. Escrow Escrow instructions
Escrow instructions: Document(s) signed by buyer and seller when escrow opened.
Direct escrow agent to take steps necessary to close transaction.
Reflect contingencies and other requirements in purchase agreement.
Specify conditions that must be met before escrow agent releases funds or documents.
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6. Escrow Purpose and benefits
Escrow helps ensure that:
seller receives purchase price
buyer receives clear title
lender’s security interest perfected
Two main benefits:
Convenience – neither party has to attend closing in person.
Protection against other party’s change of heart.
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7. Escrow Purpose and benefits
Deposit into escrow is essentially irrevocable.
After delivering funds or documents to escrow agent, can’t get them back except:
according to conditions set forth in escrow instructions, or
with other party’s consent.
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8. Escrow Escrow agent’s services
Escrow agent may provide many services:
ordering title report and inspections
paying off seller’s loan and other liens
preparing documents
prorating and allocating expenses
depositing and disbursing funds
preparing settlement statement
delivering and recording documents
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9. Escrow Escrow Agent Registration Act
Washington statute requires escrow agents to be licensed and registered with Department of Financial Institutions.
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10. Escrow Agent Registration Act Licensed escrow agent
Licensed escrow agent: Company licensed to engage in escrow business in Washington under Escrow Agent Registration Act.
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11. Escrow Agent Registration Act Licensed escrow agent
Licensed escrow agent (company) must:
comply with bonding requirements
have errors and omissions insurance
keep transaction records
maintain a client trust account
employ only licensed escrow officers to handle transactions
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12. Escrow Agent Registration Act Licensed escrow officer
Licensed escrow officer: Individual licensed to handle transactions as representative of licensed escrow agent (company).
Licensed escrow officer must:
pass state exam and meet other requirements
be supervised by company’s designated escrow officer
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13. Escrow Agent Registration Act Licensing exemptions
Exempt from escrow licensing requirements:
attorneys
title companies
banks, savings and loans, and credit unions
insurance companies
federally approved lenders
parties acting under court supervision
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14. Escrow Agent Registration Act Licensing exemptions
Real estate agent exempt:
when handling escrow for transaction in which he is providing brokerage services
as long as he doesn’t charge additional fee for escrow services
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15. Summary Escrow Closing or settlement Escrow
Escrow agent or closing agent
Escrow instructions
Escrow Agent Registration Act
Licensed escrow agent
Licensed escrow officer
Designated escrow officer
Exemptions
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16. Closing Costs
Closing costs: Fees, charges, and expenses related to a real estate transaction that are typically paid at closing.
Particular cost may be paid by buyer or by seller, or shared by both.
Either party may have to pay:
the other party
a third party
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17. Closing Costs Allocation
Purchase agreement form and/or escrow instructions often state which party is responsible for certain closing costs.
Buyer and seller may agree to different allocation and modify contract form.
Costs not addressed in contract allocated by escrow agent according to custom.
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18. Settlement Statements
Settlement statement: Document that sets out financial details of transaction, providing an accounting for buyer and seller. Also called a closing statement.
Lists closing costs, all other payments into and out of escrow.
Shows how much cash:
buyer will need for closing
seller will receive at closing
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19. Settlement Statements
Escrow agent prepares settlement statement for each party when sale ready to close.
For most home sales, uniform settlement statement form (HUD-1) must be used.
We’ll describe simplified format, to make settlement statements easy to understand.
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20. Settlement Statements Four-column format
Simplified settlement statement has four columns:
buyer’s debits
buyer’s credits
seller’s debits
seller’s credits
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21. Settlement Statements Debits and credits
Debit: An amount to be paid by one of the parties.
Credit: An amount to be paid to one of the parties.
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22. Settlement Statements Amounts one party pays the other
Amounts paid by one party to the other party are a debit for one and a credit for the other.
These are listed in two columns.
Example: Purchase price
Listed in buyer’s debit column.
Also listed in seller’s credit column.
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23. Settlement Statements Amounts paid to or by third party
Amounts one party pays to or receives from a third party are listed in only one column.
Example: Loan origination fee
Buyer owes fee to lender.
Listed only in buyer’s debit column.
Does not appear in seller’s columns.
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24. Settlement Statements Total credits match total debits
In four-column format, each party’s total credits should equal his or her own total debits.
Settlement statement like check register for bank account.
At closing, after all deposits (credits) and withdrawals (debits) made, each party’s balance should be zero.
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25. Settlement Statements Allocation of credits and debits
Purchase price Buyer’s debit Seller’s credit
Earnest money deposit Buyer’s credit
Sales commission Seller’s debit
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26. Allocation of Credits and Debits Buyer’s financing
Buyer’s new loan Buyer’s credit
Assumed loan Buyer’s credit Seller’s debit
Seller financing Buyer’s credit Seller’s debit
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27. Allocation of Credits and Debits Seller’s loan payoff
Seller’s loan payoff Seller’s debit
Prepayment penalty Seller’s debit
Reserve account refund Seller’s credit
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28. Allocation of Credits and Debits Charges connected with buyer’s loan
Appraisal fee Buyer’s debit
Credit report fee Buyer’s debit
Survey fee Buyer’s debit
Loan origination fee Buyer’s debit
Discount points Buyer’s debit
Seller-paid points Seller’s debit
Assumption fee Buyer’s debit
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29. Allocation of Credits and Debits Title insurance premiums
Owner’s title insurance Seller’s debit
Lender’s title insurance Buyer’s debit
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30. Allocation of Credits and Debits Other items
Personal property Buyer’s debit Seller’s credit
Inspection fee Debit to party ordering inspection
Hazard insurance Buyer’s debit
Excise tax Seller’s debit
Attorney’s fees Debit for each party
Recording fee Debit for each party
Escrow fee Debit for each party
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31. Summary Settlement Statements
Closing cost
Settlement statement
Debit
Credit
Amounts paid by one party to the other
Amounts paid to or by a third party
Total credits and total debits
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32. Settlement Statements Prorations
Prorate: To divide and allocate an expense proportionately, according to time, interest, or benefit.
Expense must be prorated if a party is responsible for only part of it.
Escrow agent calculates share that must be paid by or refunded to that party.
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33. Prorations As of closing date
Responsibility for property expenses generally begins and ends with period of ownership.
Also true of entitlement to financial benefits.
Items commonly prorated as of closing date:
property taxes
mortgage interest
insurance premiums
rents (from income-producing property)
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34. Prorations 3 steps
Calculate daily rate of an expense, called the per diem rate.
Determine number of days one party is responsible for the expense.
Multiply number of days by per diem rate to determine that party’s share.
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35. Prorations Step 1: Per diem rate
To calculate per diem rate:
Annual expense:
divide by 365 days
366 days in leap year
Monthly expense:
divide by number of days in month when closing occurs (28, 29, 30, or 31)
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36. Prorations Step 1: Per diem rate
Occasionally an exam question may instruct you to use a 360-day year in order to simplify calculations.
If you see a question with those instructions, assume that all months have 30 days.
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37. Prorations Step 2: Number of days
Count number of days between closing date and beginning or end of month in which closing will occur.
Beginning of month for seller’s share.
End of month for buyer’s share.
Proration questions should tell you:
whether to count the day of closing
whether to use 360-day year and 30-day months
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38. Prorations Step 3: Rate × Days
Final step: multiply per diem rate by number of days.
Result is the party’s prorated share.
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39. Prorations Prorating property taxes
Property taxes are:
seller’s responsibility up to closing date
buyer’s responsibility from closing date forward
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40. Prorating Property Taxes Paid in advance or in arrears
buyer debited for days following closing date that advance payment covers
seller credited for same amount
Taxes in arrears (not yet paid):
seller debited for days before closing date that eventual tax payment will cover
buyer credited for same amount
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41. Prorating Property Taxes Example
Closing date: July 14. Annual property tax bill: $1, Seller already paid entire amount. How much does buyer owe?
Step 1: $1, ÷ 365 days = $3.29 per diem
Step 2: 18 days (July) + 31 (Aug.) + 30 (Sept.) (Oct.) + 30 (Nov.) + 31 (Dec.) = 171 days
Step 3: $3.29 per diem × 171 days = $562.59
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42. Prorations Prorating hazard insurance
Hazard insurance is paid for in advance.
At closing, seller entitled to prorated refund of part of premium.
Refund is credit for seller.
Buyer not debited for prorated share unless buyer assuming seller’s policy.
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43. Prorating Hazard Insurance Example
Closing date: Nov. 22. Annual premium ($310.25) paid in advance, on March 1 of this year, for coverage through Feb. 28 of next year. How much will be refunded to seller?
$ ÷ 365 = $0.85 per diem
Count days: 9 (Nov.) + 31 (Dec.) + 31 (Jan.) (Feb.) = 99 days
$0.85 per diem × 99 days = $84.15
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44. Prorations Mortgage interest
Two types of mortgage interest usually must be prorated at closing:
final interest payment on seller’s loan (debit for seller)
prepaid interest for buyer’s loan (debit for buyer)
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45. Prorating Interest Seller’s final interest payment
Mortgage interest is paid in arrears.
Example: Payment made April 1 includes interest that accrued in March.
So seller’s final mortgage payment did not include interest for month in which closing takes place.
Seller must pay this interest at closing.
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46. Seller’s Final Interest Payment Example
Closing date: May 7. Seller already made her May 1 mortgage payment. Loan balance is $98,550, interest rate is 10%. How much interest will seller owe at closing?
$98,550 × .10 = $9,855 annual interest
$9,855 ÷ 365 = $27 per diem
May 1 through May 7 = 7 days
$27 × 7 days = $189 debit for seller
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47. Prorating Interest Buyer’s prepaid interest
Prepaid interest: Mortgage interest buyer pays at closing to cover period from closing date until end of month in which closing occurs.
Necessary because buyer not required to make loan payment the month following the closing month.
If closing date Aug. 12, first loan payment due Oct. 1. First payment includes interest for September, but not interest for August.
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48. Buyer’s Prepaid Interest Example
Closing date: Sept. 9. First loan payment due Nov. 1. Loan amount $156,000, interest rate 9%. How much prepaid interest will buyer owe at closing?
$156,000 × .09 = $14,040
$14,040 ÷ 365 = $38.47
Sept. 9 through Sept. 30 = 22 days
$38.47 × 22 days = $846.34
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49. Prorations Rent from income property
When income-producing property sold, may be necessary to prorate rent.
Rent usually paid in advance.
At closing, seller pays buyer prorated share of rent already collected for month in which closing occurs.
Note that security deposits are not prorated.
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50. Settlement Statements Cash at closing
To determine balance due to seller (amount seller will take away from closing):
add up seller’s credits
add up seller’s debits
subtract seller’s debits from seller’s credits
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51. Cash at Closing Balance due to seller
On simplified settlement statement, balance due to seller listed in seller’s debit column.
That way, total in seller’s debit column equals total in seller’s credit column.
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52. Cash at Closing Balance due from buyer
To calculate balance due from buyer (amount buyer needs to bring to closing):
add up buyer’s credits
add up buyer’s debits
subtract buyer’s credits from buyer’s debits
Balance due from buyer entered in buyer’s credit column.
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53. Settlement Statements Column totals
Remember that buyer’s column totals don’t have to match seller’s column totals; in fact, they virtually never will.
It’s as if each party has own checkbook, and each checkbook must be balanced separately.
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54. Summary Prorations and Cash at Closing
Per diem rate
Prepaid interest
Balance due from buyer
Balance due to seller
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55. Income Tax Aspects of Closing
Federal income tax laws that apply to real estate closings:
Form 1099-S reporting
Form 8300 reporting
FIRPTA
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56. Income Tax Aspects of Closing Form 1099-S reporting
Escrow agent or other closing agent required to report sale of real property to IRS.
Sale reported on form 1099-S, with:
seller’s name
seller’s social security number
gross sale proceeds
Agent can’t charge separate fee for filing S.
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57. Income Tax Aspects of Closing Form 1099-S reporting
Sale of principal residence exempt from 1099-S reporting requirement if:
seller certifies that none of the gain is taxable
property sold for $250,000 or less ($500,000 or less if seller married)
Certain other transactions also exempt from requirement.
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58. Income Tax Aspects of Closing Form 8300 reporting
Escrow agent who receives more than $10,000 in cash must report payment to IRS using form 8300.
Form must be filed within 15 days of receiving cash.
Copy should be kept for 5 years.
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59. Income Tax Aspects of Closing FIRPTA
Foreign Investment in Real Property Tax Act: Federal law designed to prevent foreign investors from evading tax liability on income generated from sale of U.S. real estate.
Requires real estate buyer to determine whether seller is “foreign person.”
Not U.S. citizen, not resident alien.
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60. Income Tax Aspects of Closing FIRPTA
If seller is foreign person, buyer must:
withhold 10% of amount realized (sales price)
send money to IRS within 20 days of closing date
In most cases, escrow agent handles FIRPTA compliance for buyer.
Many residential transactions exempt from FIRPTA.
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61. RESPA
Real Estate Settlement Procedures Act: Federal law regulating closing process for most residential transactions.
Goals of law:
provide borrowers with closing cost information to help them shop for settlement services
eliminate kickbacks and unnecessary fees that increase closing costs
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62. Transactions Subject to RESPA Federally related loans
RESPA applies to any federally related loan transaction that is not exempt.
Transaction federally related if:
1. loan is secured by residential property; and
2. lender has a connection with the federal government.
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63. Transactions Subject to RESPA Federally related loans
Specifically, federally related loan secured by:
property on which there is (or on which loan proceeds will be used to build) a dwelling with four units or less
condominium unit or co-op apartment
lot on which there is (or on which loan proceeds will be used to place) a mobile home
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64. Transactions Subject to RESPA Federally related loans
In addition, lender:
is federally regulated,
has federally insured accounts,
is assisted by federal government,
makes loans through federal program,
sells loans to Fannie Mae, Ginnie Mae, or Freddie Mac, or
makes real estate loans totaling more than $1,000,000 per year.
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65. RESPA Exemptions RESPA does not apply to: purchase of 25 acres or more
business, commercial, or agricultural loan
vacant land (unless dwelling to be put on it)
temporary financing (construction loan)
assumption, if lender’s approval not required or obtained
seller-financed transaction
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66. RESPA Requirements
Within 3 business days of loan application, lender must give applicant:
HUD booklet that explains RESPA, closing costs, and settlement statements
Mortgage servicing disclosure statement
Good faith estimate of closing costs (GFE)
Applicant can’t be charged fees other than credit report fee until GFE given.
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67. RESPA Requirements Service provider disclosures
Special disclosures required if lender or other settlement service provider:
requires borrower to use specific service provider (title company, appraiser, etc.), or
refers borrower to affiliated provider.
Use of affiliated service provider must be optional, and fee estimates must be given.
Also, seller can’t require buyer to use particular title company.
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68. RESPA Requirements Uniform settlement statement
Closing agent must itemize closing costs on uniform settlement statement (HUD-1 form).
Must be given to buyer, seller, and lender on or before closing date.
Buyer (borrower) must be allowed to inspect statement at least one business day before closing, if requested.
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69. RESPA Requirements Limit on reserve deposits
Lender can’t require excessive deposits into reserve account for taxes, insurance, other recurring costs.
No more than necessary to cover expenses when due, plus two-month cushion.
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70. RESPA Requirements Kickbacks and unearned fees
Lenders and other settlement service providers (including real estate agents) can’t:
pay or receive fees or kickbacks for referring customers
pay or receive unearned fees for services not actually provided
charge a fee for preparation of uniform settlement statement, reserve account statement, or TILA disclosures
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71. RESPA Requirements Estimated vs. actual costs
Actual closing costs don’t necessarily match good faith estimate.
RESPA has rules regarding which charges may increase at closing.
Can’t increase: lender’s points and fees; transfer (excise) taxes.
Total can increase by no more than 10%: charges for required services if lender chose or recommended service provider.
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72. Summary Federal Laws and Closing
Form 1099-S reporting
Form 8300 reporting
FIRPTA
RESPA
Federally related loan
Good faith estimate of closing costs
Settlement service provider
Uniform settlement statement (HUD-1)
Kickback
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