CHAPTER 14: CLOSING THE REAL ESTATE TRANSACTION
CHAPTER HIGHLIGHTS
1.
What does closing mean and what happens during closing?
The term closing, or settlement, is used to describe the final step in a real estate transaction. This is the time when
documents are signed, the buyer pays the agreed purchase price, and the seller delivers title to the buyer.
2.
What does the purchase contract do?
The terms of the purchase contract control how specific items should be handled at the closing, and frequently the
parties agree to share, or prorate, the cost of certain items.
3.
Who is the settlement agent?
The settlement agent coordinates the closing. A settlement agent can be an attorney, lending institution, real estate
broker, or title insurance company. The closing is usually held at the settlement agent’s office.
4.
What does the settlement agent do?
At the closing, the settlement agent acts as a master of ceremonies, distributing, and explaining each document that
the parties must sign, and then collecting the signed documents and distributing copies to the appropriate parties. In
addition, the settlement agent keeps a copy of each document for the agent’s own file that may prove useful should
questions arise after the closing. After all documents have been signed (e.g., the buyer signs the note and mortgage,
and the seller signs the deed), the settlement agent distributes checks.
5.
When is the closing considered complete?
Once the parties sign all the documents and receive their respective checks, the closing is complete.
6.
What else is the settlement agent responsible for?
The settlement agent’s duties do not end with the conclusion of the meeting. The agent may be responsible for
having certain documents recorded, and is responsible for mailing other monies due, such as inspection fees. To help
ensure collection of any income tax due on the sale or exchange of residences with four or fewer units, the Internal
Revenue Service (IRS) requires that the settlement agent report the details of the closing to the IRS.
7.
Explain the Real Estate Settlement Procedures Act (RESPA).
RESPA was specifically designed to eliminate several abuses that had occurred too frequently in real estate
transactions. The Act covers the following three major areas:
1. It limits the amount of money that home buyers/borrowers may be required to place in escrow to partially cover
the costs of future expenses such as hazard insurance premiums and property taxes.
2. It makes illegal the payment of kickbacks that increase the cost of some settlement services.
3. It requires lenders to disclose closing costs to both the buyer and seller in advance of the closing.
8.
What is the primary benefit of RESPA?
Perhaps the primary benefit of RESPA is that it requires lenders writing federally related mortgage loans to fully
disclose closing costs in advance of the closing. By RESPA definition, a federally related mortgage loan is any
mortgage loan made by a lender regulated or insured by the federal government or covered by the Consumer
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Protection Act, and who makes or invests in more than $1,000,000 per year in residential real estate loans; or any
mortgage loan that is eligible to be purchased by various organizations (e.g., Federal National Mortgage
Association, Federal Home Loan Mortgage Corporation) in the secondary mortgage market.
9.
How are closing costs disclosed?
Closing costs may be disclosed in two ways. First, lenders are required to prepare, free of charge, a good faith
estimate of closing costs at the time of the loan application using the standard, or uniform, settlement statement. In
many cases, this estimate is presented to the loan applicant on the day of the application, but the law allows delivery
of the estimate up to three days after the application date. A “good faith” estimate means that the estimate does not
have to reflect the actual amounts that will be charged on the day of the closing, but the estimate must be a
reasonable approximation based on the conditions that exist at the time of the application. When prepared by a
qualified loan officer, these estimates are usually very close to the figures actually used at closing.
RESPA also requires that within the same three-day period, lenders present the loan applicant with a copy of
“Settlement Costs and You,” a booklet prepared by the U.S. Department of Housing and Urban Development
(HUD). The booklet is designed to assist borrowers in understanding the costs and nature of real estate closing
services. Some mortgage originators have, with the approval of HUD, developed their own booklet for the same
purpose.
RESPA also requires lenders to make available, on the (business) day before the closing, a copy of the actual
settlement statement that will be used at the closing. In addition to showing the precise amounts for items that were
estimated earlier, the statement will include closing costs that were not on the original good faith estimate because
previous disclosure was not required. To secure a copy of the statement, the party requesting the information must
do so in writing at least two (business) days before the closing. If no request is received, the lender is not obligated
to provide the advance disclosure statement.
10. Explain a budget mortgage.
Most, but not all, home mortgage loans made today require escrow accounts because lenders wish to reduce the
possibility that borrowers will be unable to make the full hazard insurance premium payment or property tax
payment when due. So, lenders require borrowers to make these payments in installments together with their regular
payment of principal and interest. This type of mortgage is known as a budget mortgage.
11. What is the maximum initial deposit a lender may require to be placed in an escrow account?
According to RESPA, the maximum initial deposit that a lender may require to be placed into an escrow account is
one-sixth of the annual amount due. This does not mean, however, that the buyer’s initial costs will be limited to this
amount; only the amount of money to be placed in the escrow account is limited.
12. Explain kickbacks and fee splitting.
Under RESPA, no party can give or receive a kickback, or fee, as a result of a referral. If any party refers a
buyer/borrower to a particular party involved in the closing (e.g., attorney, appraiser, lender, real estate broker, title
company) and receives a fee for the referral, they are in violation of the Act, and subject to treble damages (three
times the amount of damage suffered by the buyer).
Fee splitting by parties associated with the closing is also prohibited unless the fees are paid for services actually
performed. This part of RESPA has resulted in some confusion because of the vagueness of the term “services
actually performed.” The intent was to prevent parties from paying or receiving referral fees under the guise of fee
splitting. Under RESPA, a seller may not require a buyer to use a particular title insurance company as a condition
of the sale. Therefore, RESPA ensures that buyers have the freedom to select the title insurance company of their
choice. However, many buyers delegate the selection to someone else.
13. What loans are and aren’t covered by RESPA?
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The basic coverage is for loans secured by a first lien on one-to-four family dwellings. Construction loans and other
temporary financing for such properties, and first lien loans on other types of property, are not covered by the Act
based on the theory that borrowers involved in such loans are more sophisticated and do not need the same level of
protection. In addition, it is important to note that RESPA does not regulate the amount of the fees that may be
charged for providing settlement services.
14. Explain the Federal Truth-in-Lending Law (FTL).
The primary purpose of FTL, which applies to a variety of lenders not just those that write mortgage loans, is to help
enable borrowers to compare the cost of different loan terms. FTL requires lenders to make full disclosure when
advertising loan terms, and to fully disclose to loan applicants, in a uniform manner, financial information contained
in loan agreements. As can be observed in the following highlighted material, the information that FTL requires
lenders to disclose to loan applicants depends upon the type of loan.
15. Explain the similarities and differences in RESPA and FTL.
Similar to the initial disclosure requirements of RESPA, the disclosures required by FTL must be made no later than
three days after the loan application is made. Unlike the initial RESPA disclosures that need only be reasonable
estimates, the disclosures required under FTL must be accurate. Under certain circumstances, it is possible for a
mortgage transaction to be covered by either FTL or RESPA, but not both.
16. What are closing costs?
Closing costs include both expenses that the buyer must pay in addition to the purchase price and expenses that are
deducted from the sale proceeds if the seller is responsible for paying them. As previously mentioned, the party
responsible for paying a particular closing cost is often determined by local custom. But, responsibility for closing
costs is subject to negotiation. For example, despite the fact that local custom dictates the buyer pay for any
inspections, the buyer may include in the offer the demand that the seller cover this cost. Certain closing costs are
fixed in amount regardless of the eventual closing date.
17. What costs are usually shared by the buyer and seller?
The cost for items such as property taxes, accrued interest on assumed obligations, and prepaid insurance premiums
are usually shared by the buyer and seller. The process of splitting these items between the parties is known as
proration, and the item itself is referred to as a prorated item. Operating expenses and rents are also prorated for
income-producing properties.
18. What is the preferred proration method?
The preferred proration method is to divide the cost of the item to be prorated by the actual number of days in the
year to arrive at a daily figure. Then, each party’s share of the total cost is determined by multiplying the daily
amount by the number of days that the party has ownership. The party who is assigned the cost or income for the
closing date usually depends on local custom, but again this is subject to negotiation.
In many areas, it is customary to assign costs and income for the closing day to the buyer. Even the date to be used
as the cutoff in the proration is subject to negotiation. Usually, the cutoff date is the closing date, but the parties may
mutually agree to another date.
19. What is a settlement statement?
The settlement statement shows the financial details of the transaction and is used by the parties to settle at the
closing. Also known as a closing statement or adjustment sheet, it provides an accounting of the real estate
transaction, and is prepared either by an attorney, an escrow agent, a real estate broker, or other designated party.
The closing statement itemizes closing costs, indicates how they are allocated between the seller and buyer, and all
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the cash received and paid out in the transaction. For some transactions, settlement statements may be individually
drafted documents, but preprinted forms are widely used.
20. Explain an escrow arrangement.
An alternative to the closing meeting discussed above is an escrow arrangement, or escrow closing. In an escrow
closing the buyer and seller perform separately, rather than have a joint meeting. Both parties execute and deliver all
documents and monies to an independent third party, the escrow agent (who is compensated with a fee that is
usually split equally between the seller and buyer). In a few states, real estate brokers have authority to handle an
escrow closing, but it is more common to have a title company, a lending institution, or a licensed escrow company
perform this function.
21. What does an escrow agent do?
The duties of an escrow agent are similar, but perhaps more diverse, than those of a settlement agent. The escrow
agent performs such duties as ordering title evidence, clearing encumbrances from the title, calculating prorations,
preparing the settlement statement, obtaining needed signatures, and recording documents. The escrow agent holds
the funds and documents until all the terms and conditions specified by the parties have been satisfied. Then the
agent distributes all funds and documents according to either the escrow instructions contained in the purchase
contract, or according to the instructions given under a separate document known either as an escrow agreement, or
escrow instructions.
22. What are escrow instructions?
Escrow instructions detail the steps necessary to close a transaction and direct the escrow agent how to proceed. To
be valid, both the seller and buyer must sign the escrow agreement, although sometimes both prepare separate
instructions. Care must be exercised in preparing the purchase contract or separate escrow instructions; otherwise
delays may occur in finalizing the transaction. In the event of a disagreement, escrow can only be revoked, or
changed, by mutual agreement. To ensure that they receive their commission, brokers need to be parties to the
escrow agreement. Otherwise, the seller may successfully order the escrow agent not to pay any commission.
23. What are the differences between a closing meeting and an escrow closing?
Escrow closings are common practice in some states. They are also used in cases when it is inconvenient for both
parties to attend the closing, for example, if either party is living in a different state, or, as in one case, where the
seller had treated the buyers rudely during negotiations and did not wish to face them at closing. An escrow
arrangement is required for some transactions. In some cases, escrow arrangements provide increased convenience
or flexibility. Finally, escrow closings are also used to simplify transactions involving several lenders.
24. What is a back-to-back escrow?
A back-to-back escrow, or double escrow, is an escrow established to facilitate the concurrent sale of one property
and the purchase of another. For example, if one needed the proceeds from the sale of one property as the down
payment for another, the escrow agent could easily do this. Of course, the same thing could be accomplished by
holding back-to-back closings attended by the parties; in fact, this is not uncommon.
25. What is a drawback of a back-to-back escrow?
A potential drawback of back-to-back closings is the possibility that the two closings will be held at different
locations. Investors sometimes use a double-escrow to generate a profit without long-term ownership of the
property. In essence, the buyer’s money in the second escrow is used to purchase the property in the first escrow.
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