Closing Real Estate Transactions
Intended Learning Outcomes
· Describe the preliminary steps to closing a transaction
· Describe the objective of a pre-closing inspection
· Know the provisions of the Real Estate Settlement Procedures Act of 1974 (RESPA) concerning (1) disclosures at the time of application; (2) disclosures before settlement; and (3) RESPA prohibitions
· Know IRS reporting provisions concerning foreign investors
· Describe the various sections of the HUD-1 Settlement Statement
· Prorate property taxes, mortgage interest, and prepaid rent
· Prepare a HUD-1 Settlement Statement
Real Estate Settlement Procedures Act
Broker’s Role in Closing
Ensuring that a transaction closes properly is just as important as helping the buyer and seller reach an agreement. A professional real estate licensee will be available to assist the parties if requested and confirm that the closing agent is received all necessary information and documents.
The closing of a real estate transaction occurs when title to a property is transferred from the seller to the buyer. Remember, the title is conveyed when the deed is delivered by the grantor and voluntarily accepted by the grantee. For the seller to be willing to deliver the deed, the buyer must be willing to deliver money or other property that has been agreed upon in the sale and purchase agreement. Before the buyer pays the expected price, there needs to be an assurance that the title being conveyed is marketable and does not have encumbrances that are unacceptable.
Preliminary Steps to a Closing
Overview: Even after a Purchase and Sales Agreement is signed, there are many tasks to accomplish before the closing can take place. Though a contract is signed, technically the property is not “sold” unless the closing has actually taken place. Once a contract has been signed, the licensee should notify the MLS that the property is “under contract.”
The details and arrangements at closing are governed by the sale and purchase agreement. This document should be specific regarding the following aspects of closing:
1. Date of closing
2. Place of closing
3. Purchase price
4. Quality title and method of insuring that quality
5. Financing if required
6. Type of deed being conveyed
7. Exclusion of real property
8. Inclusion of personal property
The earnest money deposit must be delivered to the broker “immediately” and timely placed in an escrow account. Some contracts provide for additional deposits to be remitted after the initial earnest money deposit. Those additional deposits should also be placed in an escrow account.
If the buyer intends to finance the transaction, the appropriate mortgage application should be submitted as soon as possible. If the Purchase and Sale Agreement contains a financing contingency, the buyer will be entitled to cancel the contract if unable to obtain mortgage financing. The contract may also contain other contingencies that must be satisfied before a party is obligated to perform, such as a satisfactory structural report (home inspection), approved title search and commitment, or termite inspection.
As part of the financing process, the property will have to be appraised by an appraiser acceptable to the lender. The appraisal must confirm the property’s value so that the bank’s collateral will be sufficient in the event of a payment default.
Sometimes, the buyer will require certain items to be repaired or replaced as a condition of closing. Obviously, such items should be addressed as soon as possible preventing last-minute concerns and anxieties.
Other matters that must be addressed prior to closing include having a survey performed (if required by the lender or title insurance company) and providing the closing agent with proof of hazard, flood, and homeowner’s insurance.
As the closing day approaches, the agent(s) should arrange a property PRE-CLOSING INSPECTION and co-ordinate the actual date, place, and time of the closing. The agents should also review all closing documents with their respective clients at least one day before closing. That way, all issues, questions, and problems can be addressed and resolved without delaying the closing. Also, the escrow agent must deliver the earnest money deposit for closing.
When a person buys real estate in Florida, the condition of its title should be of the utmost importance. The title needs to be examined by an expert to make sure negative information or claims have not attached that will then become the responsibility and problem of the new owner. For example, if a debt is owed, a lien in the amount of the debt could be attached to the property causing a new owner to lose title in a foreclosure proceeding.
An ABSTRACT OF TITLE is a complete history of a property that could date back to its origin (patent deed). The abstract contains every legal event that has ever happened to that property including deeds or other conveyances, mortgage liens, a satisfaction of mortgage, divorces, and foreclosures. A chain of title, on the other hand, is simply a history of ownership. The chain of title is part of the abstract.
Once a person has had the title examined (title search), an expert (real estate attorney) can give a written opinion of the title’s condition. If the title examination demonstrates that title is marketable, title insurance can be purchased to protect against future claims that might be made against the property or new property owner.
There are two types of title insurance:
- Owner’s Policy: The owner’s title insurance policy, also referred to as the mortgagor’s policy, is usually based on the purchase price and will pay for all claims made against the property up to the face amount of the policy. An owner’s policy is non-transferable.
- Lender’s Policy: The lender’s title insurance policy, also referred to as the mortgagee’s policy, is required by the lender if a property is mortgaged. This policy will cover the lender’s investment. A lender’s policy is transferable.
In practice, the mortgagee’s policy covers the bank’s investment while the owner’s policy covers the owner’s equity up to the original purchase price. A property owner may subsequently increase the face amount of his or her title insurance by paying an additional premium.
Some contracts are contingent upon the successful completion and buyer approval of certain inspections, including:
- Termite inspection
- Mold inspection
- Construction quality inspection
- Attorney approval of closing documents, homeowner or condo documents, and condition of title
Real Estate Settlement Procedures Act (RESPA)
RESPA was created primarily to provide disclosure to borrowers of closing costs that might be incurred while buying a home. Lenders are required to provide applicants:
1. An information booklet on borrowing within three days of application
2. A good faith estimate of closing costs within three days of application
3. A uniform settlement statement (HUD-1) no later than closing. If the borrower wishes to review the settlement statement prior to closing, the lender/closing agent must provide at least one day for such a review.
RESPA prohibits lenders from receiving referrals or kickbacks from closing-related businesses unless an actual service was provided. The Real Estate Settlement Procedures Act applies to residential loans made by institutional lenders.
IRS Reporting Requirements for Foreign investors
Foreign investors who are selling a real property located in the United States may be subject to a withholding of 15% of the gain realized from the sale at closing. The Foreign Investment in Real Property Tax Act (FIRPTA) is a federal law requiring closing agents to withhold the proceeds and report the same to the Internal Revenue Service. There are several exemptions under this law, so brokers should advise their clients to seek the advice of a tax professional if the client is possibly subject to this law. For example, one exemption provides that if the seller is selling a personal residence and the amount realized does not exceed $300,000, no withholding is required.
Preparation of the Closing Statement
Note: Florida brokers may conduct closings.
A blank sample closing statement can be found at the back of this unit for your review. You will be handed a composite closing statement on the licensing exam. Please print and reference this form as you complete the sample closing material.
The contract between the seller and the buyer will be the determining factor on what is charged to whom. The broker should check to make sure the proper person is charged with the correct items and that the amount for each is correct.
List of Charges Commonly Used in Closing
Credited to the seller:
- Sale Price
- Prorations such as rent or water
Credited to the Buyer:
- Earnest money
- New loan
- Prorated taxes, advance rents
- Security deposits
Debited to the Seller:
- Loan(s) to be paid
- Interest on loan
- Prorated taxes
- Security deposits or prepaid rents
- Title insurance for the owner
- Preparation of the deed
- State transfer tax on the deed
- Attorney fees
Debited to the Buyer:
- Sale price
- Title insurance – lender (mortgagees)
- Preparation of mortgages and deed
- Recording of deed
- Recording of mortgage
- Documentary tax on Note
- Intangible tax on mortgage
- Attorney fees
- Interest adjustment
The HUD-1 Statement
The HUD-1 statement is universally used by most closing agents, whether the transaction is federally-related or not. The closing agents use computer software to complete the form for quick and easy use.
To obtain a HUD-1 form, go to https://portal.hud.gov/hudportal/documents/huddoc?id=1.pdf
The first section, A-I, is information about the property and the buyer and seller, as well as the type of loan. This will be important information to identify the property and the parties.
Section J, lines 100-302, is information about the buyer and includes the amount due from the buyer, the proration adjustments, earnest money, etc. Line 302 shows the amount already paid, and the amount due from the buyer is shown on line 303. This is a compilation of the numbers on the backside of HUD-1, lines 700-1400.
Section K, 400-603, belongs to the seller and his debits and credits, including such items as prorations of taxes, the contract sales price, settlement charges, etc. These are compilations from line L700 on the seller’s side of the reverse side of HUD-1. The numbers are brought from 1400 and entered into 600-603 and should match.
Line 603 is the line that shows the cash paid to the seller (unless the seller owes more than he receives) and Line 303 shows how much balance is due from the buyer in a cashier’s check to be presented at closing.
Using the 365-Day Method of Calculating
Most closers in Florida use the 365-day method of calculating expenses to go on the closing statements. Use actual days with this method: January has 31 days, June has 30 days, etc.
The seller owes June interest on his loan that he is going to pay off at the closing on June 10. The amount of the loan is $150,345.00. His interest rate is 6%. How much interest will the seller owe on his loan?
Step One: Compute the annual interest: multiply the loan balance times the interest rate to derive the annual interest. This is $9,020.70 annual interest.
Step Two: Compute daily interest: divide the annual interest by 365 days. This makes the cost per day $24.71.
Step Three: Compute interest owed: count all the days to closing and multiply by the daily interest amount = 10 x $24.71= $247.10.
Whenever the 365-day method is used, the number it is divided into must be an annualized number!
Prorations are figured at midnight the day before closing, but interest for the buyer and seller is figured on the day of closing unless otherwise stated in the problem.
Items Typically Prorated between Buyer and Seller
At closing, some items associated with the subject property are shared between the buyer and the seller through the process of proration. At closing, each party’s obligation is calculated as either a debit or credit to the buyer or the seller. A debit is an item (amount of money) that is charged to a party. A credit is an item (amount of money) that is being paid to the party receiving the credit. All items on a closing statement are characterized as either a debit or a credit. Items that are prorated at the closing include property taxes, homeowner’s fees, rent (if a tenant will continue to reside on the property after closing), and pre-paid interest on an assumed mortgage loan.
Proration calculations are temporal, meaning they are based upon a period of time. For example, property taxes are based upon a calendar year. Rent and pre-paid mortgage interest are typically based upon a monthly schedule. When calculating the pro-ration, either the 365-day method or 360-day method is utilized. If the item is truly a yearly amount (such as property taxes), the 365-day method is used. That is, the annual taxes are divided by 365 to determine the daily amount. Once the daily amount is known, the closing agent determines the number of days allocated to each party and calculates the appropriate debit/credit. If the item is based upon a 30-day month method (such as mortgage interest), the annual amount is divided by 360 to determine the daily amount. All months are considered to have thirty days. Banks like the 360-day method because it gives the bank just a little more interest every day. When multiplied by thousands of mortgage loans, the additional amount can be significant.
Prorating property taxes
Property taxes (also known as ad valorem taxes) are calculated on a yearly basis and are paid in arrears, meaning that they are due and payable at the end and not paid in advance. At closing, the seller gives the buyer a credit for the seller’s portion of the yearly taxes. The seller’s portion begins on January 1st and continues until the day of closing.
Example: Using the 365-day method, prorate the taxes between the seller and the buyer for a property having annual taxes of $8,030, day of closing is March 1st, with the seller paying the taxes for the day of closing (“day of closing goes to the seller”).
1/1 Seller Share 3/1 Buyer Share 12/31
60 days 305 days
Since taxes are paid in arrears, we are concerned with the period of time from the date of closing back to January 1st of the same year.
1. Calculate the daily tax$8,030 ÷ 365 days = $22 per day
2. Calculate the # of days January 31 days
that go to the seller February 28 days
March 1 day
3. Multiply the # of seller $22 x 60 days = $1,320 debit seller/credit buyer
days by the daily tax rate
Prorating association dues
Homeowners’ associations’ dues are collected monthly and paid, in most cases, annually; while condominium association bills are paid early and collected monthly.
The proration of most expenses, including taxes, mortgage, interest, and insurance premiums, in most localities uses a 360-day year, which is divided into 12 30-day months. The actual proration is then determined by summing the monthly bills and daily bills according to the following formulas:
Monthly Rate = Yearly Rate / 12
Daily Rate = Monthly Rate / 30
Prorated Credit or Debit = (Number of Full Months × Monthly Rate) + (Number of Days in the Partial Month × Daily Rate)
The buyer and seller close on October 18. Real estate taxes of $3,600 on the property will be paid by the buyer at yearend. Then, using a banker’s year, the calculations are as follows:
Monthly Prorated Rate = $3,600 / 12 = $300
Daily Prorated Rate = $300 / 30 = $10
Prorated Debit to Seller = $300 × 9 + 18 × $10 = $2,880 = Prorated Credit to Buyer.
If the real estate taxes had been prepaid by the seller, then the credit to the seller and the debit to the buyer would equal:
Prorated Credit to Seller = $300 ×2 + 12 × $10 = $720 = Prorated Debit to Buyer.
Note that $2,880 + $720 = $3,600, the total real estate tax for the year.
Some prorations, such as for the division of rents from the property, use a 365-day year (366 in a leap year). In this case, a daily bill is calculated, then multiplied by the number of pertinent days:
Daily Rate = Yearly Rate / 365
Prorated Credit or Debit = Daily Rate × Number of Days in Relevant Period
The buyer is closing on December 15 on a property that has a studio that is rented out for $310 per month, which the seller received at the beginning of December. The sales contract calls for prorating the rent through the day of closing, so the buyer is entitled to the rent for the 16 days remaining in December.
Rents are calculated using the actual number of days, but because rent is paid month to month, only the number of days in the month of the closing needs to be counted.
Daily Rent = $310 / 31 = $10
$10 × 16 = $160 = Debit to Seller = Credit to Buyer
The rent deposit is transferred from seller to buyer, so the deposit is a debit to the seller and a credit to the buyer.
If a property is being sold and the tenant is going to remain in possession, the rent for the month of closing must be shared between the buyer and seller. Because rent is paid in advance, the seller collected the full amount on the first day of the month. Since it would be unfair to allow the seller to keep all of the money when the seller doesn’t own the property for the entire month, the rent must be prorated (shared) between the seller and the buyer. The Purchase and Sale Agreement should state which party is entitled to the closing day rent.
Example: A closing takes place on June 10th. The tenant pays monthly rent of $900. The parties have agreed that the seller should receive the rent for June 10th (“day of closing goes to the seller”). Prorate the rent between the seller and the buyer
6/1 Seller’s share 6/10 Buyer’s share 6/30
10 days 20 days
Since rent is paid in advance, we are interested in the period of time from the day of closing until the last day of the month (as indicated by the line).
1. Calculate the daily rent: $900 ÷ 30 days = $30 per day
2. Calculate # days 20 days (buyer)
entitled to the buyer:
3. Multiply the # of buyer $30/day x 20 days = $600
days by the daily rent: debit seller/credit buyer
Prorating hazard insurance
This will need to be present and paid for prior to closing. The amount of the policy is given to the closing agents so they can plan for the correct amount of mortgage escrows.
Documentary stamp taxes and intangible taxes
There are three types of transfer taxes at a closing:
1. Tax stamps (or documentary stamps) on the deed: a state tax imposed on the transfer of the property based on the sales price;
2. Tax stamps (or documentary stamps) on any new or assumed mortgage: a state tax based on the amount of the mortgage; and
3. Intangible tax: a transfer tax on new mortgage loans payable to the Clerk of the Circuit Court based on the amount of the new loan.
Tax stamps on the deed. The deed is taxed in every Florida closing. It is taxed at $.70 for each $100 of the sales price and for each fractional part of $100. This is usually debited to the seller. For example, assume a property was conveyed at a sale price of 97,500. The sale price times the tax rate on $97,500 equals 975 x .70= $682.50. If the sale price were $97, 550, the cost would be 976 x.70 =$683.20.
Tax stamps on the new or assumed mortgage loan. The promissory note is taxed when a new loan is created, or if a loan is assumed. The cost is $.35 for each $100 of debt and fractional $100 for either the new loan or an assumed loan. Those loans taken Subject to Mortgage are not taxed. This is normally debited to the buyer. For example, if the new note is for $70,000, the amount of the note tax would be $245.00. This tax is also referred to as documentary stamps on the note.
Intangible tax on the new mortgage. A new mortgage is taxed at a rate of .002 mills (cost per thousand). The amount of debt is multiplied by .002 (or $2 per thousand). This is only applied to new mortgages. A new mortgage of $120,000 x .002= $240.
In Florida, the seller is responsible for the tax stamps on the deed, and the buyer is responsible for the taxes associated with the mortgage, with the accounting entries for each party as shown:
Deed taxed at .70 per $100 or fraction thereof:
Promissory Note taxed at $0.35 per $100 or fraction thereof:
New Mortgages taxed at 0.002 per $1000. The buyer is debited.
Preparation of Closing Statements—Examples
Form: The closing statement form used on the Florida broker’s test is more simplistic than the HUD-1. The composite form has all the figures appearing on one page and a broker’s statement at the bottom. It is important to know that as of July 1, 2011 the state exam will no longer include the closing state. Students, however, still must know how to calculate all pro-rations and expense problems.
The first section contains the purchase price, deposits, and financing. The second section provides for prorations and prepayments for such items such as interest, taxes, and insurance. Section three contains the closing costs expenses which are always debits.
The composite statement compares the total buyer debits to the total buyer credits while at the same time comparing the total seller credits to the total seller debits.
Click on the link below to view a blank closing statement.
The main objectives of a pre-closing inspection are to ensure that all repairs have been performed and the property is still in satisfactory condition after the seller has removed his or her personal belongings.
Under RESPA, lenders are required to provide the borrower with an informational HUD pamphlet and a good faith estimate of closing costs either at the time of application or within 3 days of application, and the closing agent must use the HUD-1 settlement statement. Additionally, the borrower is entitled to review the closing statement one day before closing.
Under the Foreign Investors Real Property Tax Act (FIRPTA), foreign investors may be subject to a 15% withholding of real estate sale net proceeds by the closing agent.
The HUD-1 form contains sections that include the name of the parties, date of closing, and property address. On the first page, the seller’s and borrower’s credits and debits are displayed while page two contains an itemization of the parties’ various closings costs.
Proration involves a process whereby the seller and buyer will fairly share the cost of an item already paid in advance by the seller (insurance, owner’s association dues, etc.) or items paid in arrears.
Vocabulary List: HUD-1 Settlement Statement