Download ppt - © 2010 Rockwell Publishing Lesson 12: Closing Real Estate Transactions Principles of California Real Estate

© 2010 Rockwell Publishing

Lesson 12:Closing Real Estate Transactions

Principles of California Real Estate


Closing

Closing: Final stage in real estate transaction. Also called settlement.

Buyer pays seller purchase price.Seller transfers title to buyer.


Escrow

In California, closing process is usually handled through escrow.

Escrow: Arrangement in which neutral third party holds money and documents for buyer and seller until transaction closes.


EscrowEscrow 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, representing buyer

and seller, until transaction is over.


EscrowEscrow instructions

The parties usually give escrow agent written instructions for closing which:

direct escrow agent to take necessary steps to close transaction

specify conditions that must be met before escrow agent releases funds or documents

reflect contingencies and other requirements in purchase agreement


EscrowEscrow instructions

If there is any conflict between escrow instructions and purchase agreement, later contract (the escrow instructions) prevails.


EscrowEscrow services

Escrow agent may provide many services, such as:

ordering title report and inspectionspreparing documentspaying off seller’s loan and other liensprorating and allocating expensesdepositing and disbursing fundspreparing Uniform Settlement Statementsdelivering and recording documents


EscrowPurpose and benefits

Escrow’s main purpose is to ensure that:seller receives purchase pricebuyer receives clear titlelender’s security interest is perfected

Escrow’s main benefits are:convenience: neither party is required to

attend closing in personprotection: each party is protected from

change of heart by other party


EscrowPurpose and benefits

Deposit into escrow is essentially irrevocable; once party has placed sum of money or document into escrow, she can’t get it back except:

according to conditions set forth in escrow instructions, or

with other party’s consent.


EscrowRole of broker

Real estate broker isn’t principal in escrow transaction and can’t direct escrow agent during closing process.


EscrowAgent’s scope of duties

Escrow agent can call for funding of buyer’s loan but does not have authority to discuss inspection results or order repairs.


Termination of Escrow

Escrow will terminate when:transaction closesescrow instructions aren’t fulfilled by

closing date (or within reasonable time, if no closing date specified), or

buyer and seller mutually agree to termination


Termination of Escrow

Escrow does not terminate:unilaterally (action by only one party)by death or incapacity of either party


Termination of EscrowInterpleader

Sometimes when transaction fails to close, disputes will arise between parties over funds or other items placed in escrow.

If dispute arises, escrow agent should file interpleader action and let court decide who gets funds.

Escrow agent should not try to decide dispute. (Not an arbitrator.)


Escrow Licensing

Independent escrow companies must be licensed by California Department of Corporations.

Only corporation may be licensed:not partnership not individual


Escrow LicensingExemptions

The following entities may provide escrow services without escrow license:

bank or savings and loaninsurance companytitle companyattorney at lawreal estate broker handling escrow for

client’s transaction


Licensing ExemptionsReal estate brokers

Broker may provide escrow services, and charge fees for those services, only in transactions in which they are also providing real estate services.


SummaryEscrow

• Closing• Escrow• Escrow instructions• Interpleader• Independent escrow company• Licensing requirements• Exemptions


Closing Costs/Settlement Statements

Closing costs: Fees and other charges related to real estate transaction that are typically paid at closing.

Particular cost may be paid by buyer or by seller, or shared by both parties.

Amounts may be paid to:other party, orthird party.


Settlement Statements

Settlement statement: Document that sets forth financial details of transaction. Also called a closing statement.

Shows how much cash:buyer needs for closingseller will receive at closing


Settlement StatementsDebits and credits

Debit: An amount to be paid by a party.

Credit: An amount to be paid to a party.



Closing costs paid by one party to the other are a debit for one and a credit for the other.

Debits and credits one party pays to or receives from a third party are a credit or debit to that party only.



Purchase price: Buyer’s debit and seller’s credit.

Assumed loan: Buyer’s assumption of seller’s loan is credit to buyer, and loan balance is a debit to the seller.



Payoff of seller’s loan: Debit to seller.No entry made on buyer’s side of

settlement statement.Escrow agent requests beneficiary’s

statement from seller’s lender, which states loan’s remaining principal balance.



Seller’s reserve account: Funds the seller’s lender required to be deposited to cover recurring costs. Also called impound or escrow accounts.

Includes property taxes, insurance, assessments, and homeowners association fees.

At closing unused balance is refunded, as credit to seller.


SummarySettlement Statements

• Settlement statement

• Credit

• Debit

• Purchase price

• Assumed loan

• Payoff of seller’s loan

• Seller’s reserve account


Prorations

Prorate: To prorate an expense is to divide and allocate it proportionally between parties, according to time, interest, and benefit.

Expenses commonly prorated include: property taxesmortgage interest paymentshazard insurance premiums


Prorations

Generally, seller is responsible for these expenses during period of ownership but not beyond; buyer becomes responsible for these expenses after taking title.

Allocation of responsibility for these expenses must be detailed in settlement statement.


Settlement StatementsProrations

To prorate an expense:calculate daily rate of expense

(per diem rate)determine number of days party is

responsible for expensemultiply number of days by per diem rate

to determine that party’s share of expense


ProrationsStep 1: Per diem rate

To find per diem rate:annual expense: divide by 365 days

(366 days in a leap year)monthly expense: divide by number of

days in month when closing occurs (28, 29, 30, or 31)


ProrationsFormulas

Although most closing agents use exact number of calendar days, state license exam may have questions that use simplified “banker’s year” of 360 days (30 days each month).

To be completely accurate, per diem rates should be carried to at least 4 decimal points.


ProrationsStep 2: Number of days

Count number of days between closing date and beginning or end of month in which closing will occur (depending on whether expense is buyer’s or seller’s responsibility).


ProrationsStep 3: Rate × Days

Final step is to multiply per diem rate by number of days, to get that party’s prorated share.


Prorations Property taxes

Property taxes are:seller’s responsibility up to closing datebuyer’s responsibility from closing date

and beyond



If taxes have been paid in advance:buyer debited for closing date and

days following that which are covered by advance payment

seller credited for same amount



If taxes are paid in arrears (not yet paid):seller debited for days before closing

date that the (buyer’s) tax payment will cover

buyer credited for same amount



Property taxes are levied once a year.In California, property tax year runs from

July 1 to June 30.

Taxes are paid in two installments:first installment due November 1

(covers July through December)second installment due February 1

(covers January through June)


Prorating Property TaxesExample

A transaction is closing January 20. The year’s property tax bill was $1,752 and the seller paid the entire amount on October 30. How much does the buyer owe? (Use a 360-day year.)

$1,752 ÷ 360 = $4.87

Count days: 11 (Jan.) + 150 (Feb.–June, 30 × 5) = 161

$4.87 × 161 days = $784.07


ProrationsInterest payments

Mortgage interest is paid in arrears.Example: Payment made on April 1

includes interest that accrued in March.

So seller’s last mortgage payment did not include interest for month in which closing will take place.

Seller must pay this interest at closing.


In addition to prorating expenses, some transactions also require proration of income (in sale of rental property).

Rent is usually paid in advance, so seller must give buyer prorated share of any advance rent (for time past closing).

Security deposits are not prorated. (Seller must transfer entire security deposit to buyer at closing, as lease continues.)

ProrationsRental income


Settlement StatementsCash at closing

To determine balance due to seller (amount seller will take away from closing):

add up all of seller’s creditsadd up all of seller’s debitssubtract seller’s debits from seller’s

credits


Settlement Statements Cash at closing

To calculate balance due from buyer (cash needed for closing):

add up all of buyer’s creditsadd up all of buyer’s debitssubtract buyer’s credits from buyer’s debits

Balance due from buyer is entered in buyer’s credit column.


Settlement StatementsFinal balances

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 his own checkbook, and each checkbook must be balanced separately.


SummaryProrations and Cash at Closing

• Proration

• Per diem rate

• Prepaid interest

• Balance due from buyer

• Balance due to seller


Tax Aspects of Closing

Nearly all real estate transactions have tax implications for parties, but certain requirements must be taken care of at time transaction closes.

Escrow agents must assure compliance with:1099-S reporting ruleFIRPTACalifornia Withholding Law


Tax Aspects of Closing1099-S reporting

The closing agent has primary responsibility for reporting every sale of real property to Internal Revenue Service.

Information is reported on Form 1099-S, which includes:

seller’s name and social security numbergross sale proceeds


Tax Aspects of Closing1099-S reporting

Although escrow agent has primary responsibility for 1099-S reporting, if escrow agent fails to report to IRS, mortgage lender is required to do so.

If lender also fails to report sale, it becomes real estate broker’s duty to file 1099-S form.


Tax Aspects of ClosingFIRPTA

Foreign Investment in Real Property Tax Act:

Federal law designed to prevent foreign investors from evading tax liability from sale of U.S. real estate.

Buyer must determine if seller is “foreign person” (not U.S. citizen or resident alien).

If “foreign” sale, buyer must withhold 10% of sales price and forward to IRS (escrow agent usually handles).


Tax Aspects of ClosingCalifornia withholding law

California also has law that requires buyers to withhold funds for tax purposes.

To comply with this law, buyer or escrow agent must withhold 3.33% of total sales price and send funds to Franchise Tax Board.

Some transactions are exempt.


RESPA

Real Estate Settlement Procedures Act (RESPA): Federal law regulating closing process for most residential transactions. Law is intended to:

give homebuyers information about closing costs that will help them compare costs and shop for settlement services

eliminate kickbacks and unnecessary fees that increase costs for consumers


RESPAFederally related loans

RESPA applies to any federally related loan transaction that is not exempt.

Loan is “federally related” if it meets two requirements: secured by (certain) real property connected to federal government

(federally regulated, insured, etc.)



The loan is secured by mortgage or deed of trust against:

property on which there is (or which loan proceeds will build) a dwelling with four units or less,

condominium unit or co-op apartment, or lot with mobile home, AND



The lender: is federally regulated, has federally insured accounts, is assisted by federal government, makes or sells loans in connection with

federal program (Fannie Mae, Ginnie Mae, etc.), or

makes real estate loans totaling more than $1,000,000 per year.



Most institutional home loans are covered by RESPA.

RESPA doesn’t apply to seller-financed transactions.


RESPARequirements

Within 3 business days of loan application, lender must give loan applicant:

HUD booklet that explains RESPA, closing costs, and settlement statements

good faith estimate of closing costs (GFE) mortgage servicing disclosure statement


RESPARequirements

If lender or other settlement service provider requires borrower to use particular appraiser or other service provider, that must be disclosed to borrower when loan application is signed.


RESPARequirements

Any referral to affiliated service provider requires disclosure of the joint business relationship.

Disclosure must include: fee estimate statement that the referral is optional


Closing agent must itemize all closing costs on Uniform Settlement Statement.

Statement 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.

RESPARequirements


If lender requires borrower to make deposits into reserve (impound) account, RESPA prohibits requiring excessive amounts.

RESPARequirements


Lenders and all other settlement providers are prohibited from:

Paying/receiving fees or kickbacks for customer referrals

accepting unearned fees (for services not actually provided)

charging fee for preparation of: Uniform Settlement Statement escrow account statement Truth in Lending Act disclosure form

RESPAProhibitions


Seller may not require buyer to use particular title company.

RESPAProhibitions


SummaryLegal and Tax Aspects of Closing

• 1099-S reporting

• FIRPTA

• California withholding law

• RESPA

• Federally related loan

• RESPA requirements and prohibitions