1. Washington Real Estate Law © Copyright 2010 Rockwell Publishing, Inc. Lesson 10: Closing and Escrow

2. © Copyright 2010 Rockwell Publishing, Inc. Introduction In this lesson: preparing for closing, escrow when title passes, RESPA, and settlement statements.

3. © Copyright 2010 Rockwell Publishing, Inc. Preparing for Closing Closing: The consummation of a transaction, when the seller delivers title to the buyer in exchange for the purchase price. Typically, closing is official when all documents are recorded. The real estate agent usually helps parties set closing date when purchase and sale agreement is signed.

4. © Copyright 2010 Rockwell Publishing, Inc. Preparing for Closing An important factor to weigh when suggesting a closing date is volume of mortgage lending. If lenders aren’t too busy and things go smoothly, closing may occur in less than 30 days. Parties can agree to extend closing date if necessary.

5. © Copyright 2010 Rockwell Publishing, Inc. Escrow Escrow: An arrangement in which money and/or documents are held by a third party on behalf of the buyer and seller and distributed according to their instructions. Escrow agent: The third party who handles escrow for the parties (a.k.a. closing agent).

6. © Copyright 2010 Rockwell Publishing, Inc. Escrow A buyer doesn’t want to pay for property until she knows seller can convey title, and seller doesn’t want to deed the property until he receives purchase price. With escrow, seller receives purchase price, buyer receives clear title, and lender’s security interest is perfected—all at same time. Purpose

7. © Copyright 2010 Rockwell Publishing, Inc. Escrow Escrow protects parties against a unilateral change of mind. Once deed is deposited with escrow agent, seller has no more control over it. When buyer meets specified conditions (such as paying purchase price), escrow agent must deliver the deed. Purpose

8. © Copyright 2010 Rockwell Publishing, Inc. Escrow Escrow is also convenient when parties live far apart, travel extensively, or are occupied with other business. Escrow allows closing process to continue even if both parties can’t meet in person. Purpose

9. © Copyright 2010 Rockwell Publishing, Inc. Escrow Escrow agent may be bank or other financial institution, title insurance company, independent escrow firm, mortgage broker, or attorney. In eastern Washington, attorneys frequently close real estate transactions. In western Washington, attorneys are not commonly used. Escrow agents

10. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents Escrow Agent Registration Act: A state law that requires companies providing escrow services to be registered and licensed by the Department of Financial Institutions. Escrow agents: Registered licensed escrow companies. Licensing

11. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents Escrow officers: The individuals that a licensed escrow agent employs to handle transactions; officers must be licensed. Designated escrow officer: A licensed escrow officer, typically an owner, required by the registration act to supervise all other escrow officers in the company. Licensing

12. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents Licensed escrow agents must keep records of all transactions. Escrow agents must place client funds in trust account. If licensed escrow agent or escrow officer converts trust funds, or commits other prohibited acts, Department of Licensing may suspend or permanently revoke license. Licensing

13. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents Certain entities are exempt from escrow licensing requirement: attorneys, title companies, most financial institutions, insurance companies, and those acting under court supervision, such as receivers, bankruptcy trustees, guardians, executors, and probate administrators. Licensing

14. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents Real estate agents handling escrow for their own transactions are also exempt, as long as they don’t charge additional fee for escrow services. In Washington, limited practice officers (LPOs) may prepare certain escrow documents and perform routine closing functions. Licensing

15. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents The law requires all escrow agents, including those exempt from the licensing/registration requirements, to treat clients and third parties fairly and honestly. Licensing

16. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents Escrow agent essentially acts as authorized dual agent, with duties to both parties. Agent must follow instructions in the escrow agreement. If agent acts contrary to instructions, she may be liable for damages. Duties

17. © Copyright 2010 Rockwell Publishing, Inc. Escrow Agents Escrow agent: reviews purchase and sale agreement and/or loan commitment for problems, orders title insurance and makes sure title defects/encumbrances are cleared up, prepares escrow instructions, and arranges for signing/recording/delivery of documents, collects funds necessary to close, and prepares settlement or closing statements. Duties

18. © Copyright 2010 Rockwell Publishing, Inc. Escrow Process The choice of an escrow agent is often left up to real estate agent or lender. Choice of agent

19. © Copyright 2010 Rockwell Publishing, Inc. Escrow Process Closing agent must be a third party—seller or buyer can’t be escrow agent. However, escrow agent does not have to be completely neutral person (though that’s usually best).  If both parties agree, closing agent may be attorney or real estate agent of the seller or buyer. Choice of agent

20. © Copyright 2010 Rockwell Publishing, Inc. Escrow Process Escrow may be opened by any of those involved in the transaction. Usually opened when real estate agent delivers copy of purchase and sale agreement to the closing agent named in the agreement. Opening escrow

21. © Copyright 2010 Rockwell Publishing, Inc. Escrow Process Escrow cannot be opened without valid written purchase and sale agreement. Opening escrow

22. © Copyright 2010 Rockwell Publishing, Inc. Escrow Process The parties’ obligations and the conditions to be fulfilled are stated in written escrow instructions. Escrow instructions are prepared by escrow agent, working from the purchase and sale agreement. Alternatively, the parties may provide instructions. Escrow instructions

23. © Copyright 2010 Rockwell Publishing, Inc. Escrow Process Joint instructions—one set of instructions that applies to both parties—is the norm. In some cases (usually commercial transactions), buyer and seller may execute separate escrow instructions. Escrow instructions

24. © Copyright 2010 Rockwell Publishing, Inc. Escrow Instructions A problem arises if the escrow instructions conflict with purchase and sale agreement. General rule: If two related contracts are inconsistent, they are interpreted together to determine the whole contract. Conflicts

25. © Copyright 2010 Rockwell Publishing, Inc. Escrow Instructions If two conflicting contracts cannot be reconciled, the latter contract controls. If purchase and sale agreement conflicts with escrow instructions, and the conflict can’t be reconciled, escrow instructions will control. Conflicts

26. © Copyright 2010 Rockwell Publishing, Inc. Escrow Instructions Escrow instructions usually contain provisions that describe: the parties and property, the deposits (purchase price, and various documents, such as bill of sale, insurance policies, etc.), the obligations of the parties, Typical provisions

27. © Copyright 2010 Rockwell Publishing, Inc. Escrow Instructions Escrow instructions, cont’d the key dates (for recording, distributing funds, etc.), the fees and costs (for escrow, title, recording, etc.), and the conditions that must be met before funds and documents are delivered to parties. Typical provisions

28. © Copyright 2010 Rockwell Publishing, Inc. Escrow Instructions The instructions usually contain time limits. If time has been made “of the essence,” agreement may become defunct if a time limit expires without performance. Courts are not always strict about enforcing this. Time limits

29. © Copyright 2010 Rockwell Publishing, Inc. Escrow Instructions Court may decide against enforcing time limit based on: intent of the parties, whether the parties have extended the time for performance, and surrounding circumstances (such as fluctuating property values making delay reasonable). A party may inadvertently waive a time limit by accepting or causing delays. Time limits

30. © Copyright 2010 Rockwell Publishing, Inc. Escrow Process Real estate agents sometimes use escrow progress chart to keep track of escrow. Chart enables agent to inform buyer and seller of the current status of escrow. Also acts as reminder of what steps still need to be taken in order to close transaction. Progress chart

31. © Copyright 2010 Rockwell Publishing, Inc. Escrow Escrow terminates in one of three ways: transaction closes, parties agree to termination, or a party defaults. Termination of escrow

32. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow When all conditions are met and deposits are distributed, escrow terminates automatically. Before authorizing escrow agent to close the transaction, buyer should inspect the property again to make sure that it’s in same shape as when agreement was signed. Closing

33. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow After closing, there may be money left over in escrow. This usually happens when a sum was deposited for an item (such as a pest inspection), but the item cost less than amount deposited. When escrow closes, parties should review their closing statements to see that all amounts have been removed from escrow. Closing

34. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow Parties may terminate escrow at any time by mutual agreement, even if transaction would otherwise close. Termination by agreement might occur if unforeseen circumstances cause both parties to realize they can’t/shouldn’t go through with transaction. Mutual agreement

35. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow If both parties agree to cancel, they should notify escrow agent. Escrow agent will usually send out a rescission or cancellation agreement, with provisions that settle all issues between the parties. Mutual agreement

36. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow Rescission/cancellation agreement should state what will happen to funds in escrow and who must pay any charges already incurred (for example, inspection fees). The escrow company itself may also charge a cancellation fee covering cost of work already completed. Mutual agreement

37. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow If one party decides to drop out of the transaction (default), that will terminate escrow. Usually, purchase and sale agreement sets forth what happens to funds in escrow if one party defaults. Example: Many escrow instructions state that if buyer doesn’t deposit remaining purchase price in escrow by closing date, escrow agent may release earnest money to seller. Default

38. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow If neither purchase agreement nor escrow instructions authorize release of deposited funds after default, closing agent can’t release the funds to one party without other party’s consent. This is true even if the funds are returned to the party who deposited them, and that party appears entitled to them. Default

39. © Copyright 2010 Rockwell Publishing, Inc. Termination of Escrow When parties can’t agree on who should get the funds, a lawsuit is likely. Escrow agent can interplead disputed funds into the court and let the court settle ownership issue. Default

40. © Copyright 2010 Rockwell Publishing, Inc. Escrow Like-kind exchange: A two-part transaction in which an investor sells an appreciated piece of property, but is able to postpone tax on the gain by using the proceeds from the sale to buy a replacement investment property. Closing like-kind exchanges

41. © Copyright 2010 Rockwell Publishing, Inc. Escrow Replacement property must be of the same general type, or “like kind,” as the original property. The investor must identify the replacement property within 45 days of selling the original property. Sale of second piece of property must close within 180 days of first sale. Closing like-kind exchanges

42. © Copyright 2010 Rockwell Publishing, Inc. Escrow Exchange facilitator: A specially trained and bonded closing agent needed for like kind- exchanges. Facilitator is needed because in a like-kind exchange, investor can’t take possession of sale proceeds from the first sale. Proceeds instead must be held by a neutral third party—the facilitator—and then used to buy replacement property. Closing like-kind exchanges

43. Summary © Copyright 2010 Rockwell Publishing, Inc. Escrow  Escrow (closing)  Escrow agent  Delivery  Escrow instructions  Like-kind exchange

44. © Copyright 2010 Rockwell Publishing, Inc. When Title Passes Generally, title to property or deposited funds remains with grantor or depositor until performance of all the conditions. Example: Seller generally remains in possession of the property, collects any rents, and pays taxes until day of closing.

45. © Copyright 2010 Rockwell Publishing, Inc. When Title Passes When title passes becomes important if something happens to property or to deposited funds. Risk of loss follows legal title. Example: If escrow agent steals deposited funds, the party who suffers the loss is the one who had title to the funds (generally, the buyer). Risk of loss

46. © Copyright 2010 Rockwell Publishing, Inc. When Title Passes If the escrow agent delivers deposited funds or deed before all conditions are met, title does not pass unless ratified by the depositor. Delivery to someone who has failed to perform required conditions is conversion. Injured party may recover damages from escrow agent and from any party who participated in wrongful delivery. Unauthorized delivery

47. © Copyright 2010 Rockwell Publishing, Inc. When Title Passes Relation back: Under certain conditions, a deed is considered delivered on the date of its deposit into escrow, not on the date when the purchase and sale agreement conditions were satisfied. Relation back doctrine

48. © Copyright 2010 Rockwell Publishing, Inc. When Title Passes The relation back doctrine applies if, after a deed has been delivered into escrow, any of the following events occur: seller dies, marries, or becomes legally incompetent, or buyer dies. In each case, if other party fulfills the requirements set forth in escrow instructions, the transaction will relate back to the date the deed was delivered into escrow. Relation back doctrine

49. Summary © Copyright 2010 Rockwell Publishing, Inc. When Title Passes  Unauthorized delivery  Relation back doctrine  Risk of loss

50. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA: The Real Estate Settlement Procedures Act, a federal law passed in 1974. RESPA applies to most federally related loans. This law requires disclosures to be made to loan applicants concerning closing costs. The act also prohibits certain practices that unnecessarily increase cost of settlement services.

51. © Copyright 2010 Rockwell Publishing, Inc. RESPA A loan is federally related if: it’s secured by mortgage or deed of trust against:  property on which there is a one- to four-unit dwelling;  a condominium unit or cooperative apartment; or  a lot with a mobile home; AND… Federally related loans

52. © Copyright 2010 Rockwell Publishing, Inc. RESPA the lender:  is federally regulated;  has federally insured accounts;  lends in connection with a federal program;  sells loans to FNMA, GNMA, or FHLMC; or  makes more than $1 million in real estate loans per year. Federally related loans

53. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA applies to most residential loans, but many other kinds of loans are exempt: loan to buy 25 acres or more; loan primarily for business, commercial, or agricultural purpose; loan to buy vacant land (unless there will be a one- to four-unit dwelling built on it or a mobile home placed on it); and assumption for which the lender’s approval is neither required nor obtained. Federally related loans

54. © Copyright 2010 Rockwell Publishing, Inc. RESPA In addition, RESPA doesn’t apply to seller- financed transactions. Seller financing is not a federally related loan. Federally related loans

55. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA imposes a number of requirements in federally related loan transactions. 1. Within three days of receiving a written loan application, the lender must give the applicant: a copy of a HUD-prepared booklet on settlement procedures that explains RESPA, closing costs and the settlement statement; Requirements

56. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA requirements, cont’d a mortgage servicing disclosure statement stating whether lender intends to service the loan or transfer it to another lender; and a good faith estimate (GFE) of the settlement costs the borrower is expected to pay.  lender or loan originator may not charge loan applicant any fees other than a credit report fee until the good faith estimate has been provided. Requirements

57. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA requirements, cont’d 2. If lender or other settlement service provider requires the borrower to use a particular appraiser, title company, etc., that must be disclosed to borrower when loan application or service agreement is signed. Requirements

58. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA requirements, cont’d 3. If settlement service provider refers borrower to affiliated provider, that joint business relationship must be fully disclosed, along with the fact that the referral is optional. Fee estimates for the services in question must also be given. Requirements

59. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA requirements, cont’d 4. The closing agent must itemize all loan settlement charges on a Uniform Settlement Statement form. Requirements

60. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA requirements, cont’d 5. Required deposits into an impound account (to cover taxes, insurance, and other recurring costs) cannot be excessive. This means deposits cannot be more than necessary to cover the expenses when they come due, plus a two-month cushion. Requirements

61. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA requirements, cont’d 6. Lender/provider of settlement services may not: pay or receive kickbacks (referral fees); pay or receive unearned fees (fees for settlement services that weren’t actually provided); or charge a fee for preparing the Uniform Settlement Statement, impound account statement, or TILA disclosure statement. Requirements

62. © Copyright 2010 Rockwell Publishing, Inc. RESPA RESPA requirements, cont’d 7. The seller may not require the buyer to use a particular title company. Requirements

63. Summary © Copyright 2010 Rockwell Publishing, Inc. RESPA  RESPA  Federally related loan  Good faith estimate (GFE)

64. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements Settlement statement (or closing statement): A statement detailing the financial aspects of the transaction. The statement sets out the items to be paid by each party, the funds the buyer will have to pay into escrow, and the net cash proceeds that will go to the seller.

65. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements If the transaction is subject to RESPA, a Uniform Settlement Statement form must be used. If RESPA does not apply, any form may be used.

66. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements The information for the buyer and seller may be combined into one statement. Usually a different statement is prepared for each party. The one given to buyer presents only buyer’s closing information, and the one given to seller presents only seller’s closing information.

67. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements Preparing a settlement statement involves allocating various amounts between the parties, as debits and credits. Debit: An amount owed, a charge that must be paid. Credit: The opposite of a debit, an amount to be received. Allocating expenses

68. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements The purchase and sale agreement usually states who pays for what. Absent that, local custom may determine how to allocate a given charge. Allocating expenses

69. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements A transaction settlement guide shows how various items are usually allocated. Transaction settlement guide will help agent determine costs to be paid by each party. Impossible to calculate exact closing costs until actual closing, but a reasonably accurate estimate can be prepared in advance. Guide

70. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements The main cost for buyer is purchase price—a debit to the buyer and a credit to the seller. New loans or assumptions of existing loans are listed as credits for the buyer. Guide

71. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements Other typical buyer costs include: loan origination fee, discount points, other loan costs (appraisal, credit report, etc.), lender’s title insurance, impound account deposits, any prepaid, or interim, interest, and other miscellaneous fees (attorney, notary, recording, etc.). Guide

72. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements Buyer’s credits include the earnest money deposit and deposits with the lender to cover initial loan costs (such as the appraisal and credit report). The buyer may also be due a credit for prorated items such as taxes or rents. Guide

73. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements The seller’s major cost at closing is normally the payoff of any existing loans. Other costs include: interest on current loan for month of closing, real estate commission, excise tax on the sale, and other miscellaneous fees (attorney, recording, etc.). Guide

74. © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements The seller’s major credit is the purchase price. The seller may also be due credits for prorated taxes and insurance premiums, and money left over in an impound account after paying off a loan. Guide

75. Summary © Copyright 2010 Rockwell Publishing, Inc. Settlement Statements  Settlement statement  Credits  Debits