LEARNING OBJECTIVES
When you've finished reading this Chapter, you should be able to:
     ► identify the issues of particular interest to the buyer and the seller as a real estate transaction closes. 
     ► describe the steps involved in preparing a closing statement.
     ► explain the general rules for prorating. 
     ► distinguish the procedures involved in face-to-face closings from those in escrow closings. 
     ► define the following terms: accrued items; closing; closing statement; controlled business arrangement (CBA); credit; debit; escrow account; escrow closing; Good Faith Estimate (GFE); impound account; Mortgage Disclosure Improvement Act (MDIA); prepaid items; prorations; Real Estate Settlement Procedures Act (RESPA); survey; and Uniform Settlement Statement (HUD-1).

REAL ESTATE PRACTICE & PRINCIPLES KEY WORD MATCH QUIZ --- CLICK HERE ---
I would encourage you to take this “Match quiz” now as a pre-chapter challenge to see how many of these key words or phrases you are familiar with. At the end of each chapter I recommend that you take the quiz again to reinforce these important keywords. Each page contains four words or phrases and you need to drag and drop the correct definition into the puzzle key. Each page is considered as a question, but there is no scoring and you can return to each chapter quiz as many times as needed to reinforce your memory. 

 WHY LEARN ABOUT... CLOSING THE REAL ESTATE TRANSACTION?
Everything a real estate licensee does in the course of a real estate transaction, from soliciting clients to presenting offers and coordinating inspections, leads to one final event: closing. Closing is the consummation of the real estate transaction. It is the time when the title to the real estate is transferred in exchange for payment of the purchase price. Closing marks the end of any real estate transaction; it is the goal toward which all the agent's efforts are driven. It's also a complicated time: Up until closing preparations begin, the agent's relationship has been primarily with the buyer or seller. During the closing period, new players come on the scene: appraisers, inspectors, loan officers, insurance agents, and lawyers. Negotiations continue, sometimes right up until the property is finally transferred, and the risk of a deal failing is high. For those reasons alone, it is vital that you understand how closings work—to ensure that they do.

 PRECLOSING PROCEDURES
Closing actually involves two events: First, the promises made in the sales contract are fulfilled; second, the mortgage loan funds (if any) are distributed to the buyer. Before the property changes hands, however, important issues must be resolved, and both the buyer and the seller have specific issues to deal with.

Buyer's Issues
The buyer will want to be sure that the seller delivers title. The buyer also should ensure that the property is in the promised condition. This involves inspecting
► the title evidence;
► the seller's deed;
► any documents demonstrating the removal of undesired liens and encumbrances;
► the survey;
► the results of any required inspections, such as termite or structural inspections, or required repairs; and
► any leases if tenants reside on the premises.

IN PRACTICE      One of the first efforts to put the NAR/HUD Homebuyer Protection Initiative into action is the Consumer Notice form that explains the difference between the appraisal and a home inspection and that emphasizes the importance of an inspection to protect buyers. The one-page notice must be signed on or before closing in all transactions in which an FHA-insured mortgage is involved.

Final property inspection.
Shortly before the closing takes place, the buyer usually makes a final inspection of the property with the broker (often called the walk-through). The right to have a final property inspection is normally created in the real estate sales contract. Through this inspection, the buyer makes sure that necessary repairs have been made, that the property has been well maintained, that all fixtures are in place, and that there has been no unauthorized removal or alteration of any part of the improvements.

Survey.
A survey gives information about the exact location and size of the property. The sales contract specifies who will pay for the survey. It is usual for the survey to "spot" the location of all buildings, driveways, fences, and other improvements located primarily on the premises being purchased. Any improvements located on adjoining property that may encroach on the premises being bought will also be noted. The survey should set out, in full, any existing easements and encroachments. Whether or not the sales contract calls for a survey, lenders frequently require one.

IN PRACTICE     A buyer should make sure that the survey is accurate so that property purchased is exactly what the buyer wanted. Relying on old surveys is not necessarily a good idea; the property should be resurveyed prior to closing by a competent surveyor, whether or not the title company or lender requires it.

Seller's Issues
Obviously, the seller's main interest is in receiving payment for the property. He or she will want to be sure that the buyer has obtained the necessary financing and has sufficient funds to complete the sale. The seller also will want to be certain that he or she has complied with all the buyer's requirements so the transaction will be completed.

Both parties will want to inspect the closing statement to make sure that all monies involved in the transaction have been accounted for properly. The parties may be accompanied by their attorneys or their real estate agents.

Title Procedures
Both the buyer and the buyer's lender will want assurance that the seller's title complies with the requirements of the real estate sales contract. Though the practice varies from state to state, the seller is usually required to produce a current abstract of title or title commitment from the title insurance company. When an abstract of title is used, the purchaser's attorney examines it and issues an opinion of title. This opinion, like the title commitment, is a statement of the status of the seller's title. It discloses all liens, encumbrances, easements, conditions, or restrictions that appear on the record and to which the seller's title is subject.

On the date when the sale is actually completed (the date of delivery of the deed), the buyer has a title commitment or an abstract that was issued several days or weeks before the closing. For this reason, there are sometimes two searches of the public records. The first shows the status of the seller's title on the date of the first search. Usually, the seller pays for this search. The second search, known as a bring down, is made after the closing and generally paid for by the purchaser. The abstract should be reviewed before closing to resolve any problems that might cause delays or threaten the transaction.

As part of this later search, the seller may be required to execute an affidavit of title. This is a sworn statement in which the seller assures the title insurance company (and the buyer) that there have been no judgments, bankruptcies, or divorces involving the seller since the date of the title examination. The affidavit promises that no unrecorded deeds or contracts have been made, no repairs or improvements have gone unpaid, and no defects in the title have arisen that the seller knows of. The seller also affirms that he or she is in possession of the premises. In some areas, this form is required before the title insurance company will issue an owner's policy to the buyer. The affidavit gives the title insurance company the right to sue the seller if his or her statements in the affidavit are incorrect.

When the purchaser pays cash or obtains a new loan to purchase the property, the seller's existing loan is paid in full and satisfied on record. The exact amount required to pay the existing loan is provided in a current payoff statement from the lender, effective on the date of closing. This payoff statement notes the unpaid amount of principal, the interest due through the date of payment, the fee for issuing the certificate of satisfaction or release deed, credits (if any) for tax and insurance reserves, and the amount of any prepayment penalties. The same procedure is followed for any other liens that must be released before the buyer takes title.

In a transaction in which the buyer assumes the seller's existing mortgage loan, the buyer will want to know the exact balance of the loan as of the closing date. In some areas, it is customary for the buyer to obtain a mortgage reduction certificate from the lender that certifies the amount owed on the mortgage loan, the interest rate and the last interest payment made.

In some areas, real estate sales transactions are customarily closed through an escrow (discussed below). In these areas, the escrow instructions usually provide for an extended coverage policy to be issued to the buyer as of the date of closing. The seller has no need to execute an affidavit of title.

IN PRACTICE      Licensees often assist in preclosing arrangements as part of their service to customers. In some states, licensees are required to advise the parties of the approximate expenses involved in closing when a real estate sales contract is signed. In other states, it is the licensees' statutory duty to coordinate and supervise closing activities.

 CONDUCTING THE CLOSING
Closing is known by many names. For instance, in some areas closing is called settlement and transfer. In other parts of the country, the parties to the transaction sit around a single table and exchange copies of documents, a process known as passing papers. ("We passed papers on the new house Wednesday morning.") In still other regions, the buyer and seller may never meet at all; the paperwork is handled by an escrow agent. This process is known as closing escrow. ("We'll close escrow on our house next week.") Whether the closing occurs face to face or through escrow, the main concerns are that the buyer receives marketable title, the seller receives the purchase price, and certain other items are adjusted properly between the two.

Face-to-Face Closing
A face-to-face closing involves the resolution of two issues. First, the promises made in the real estate sales contract are fulfilled. Second, the buyer's loan is finalized, and the mortgage lender disburses the loan funds. The difference between a face-to-face closing and an escrow closing is that in a face-to-face closing, these two issues are resolved during a single meeting of all the parties and their attorneys. As discussed earlier, the parties in an escrow closing may never meet. The phrase passing papers vividly describes a face-to-face closing.

Face-to-face closings may be held at a number of locations, including the office of the title company, the lending institution, one of the parties' attorneys, the broker, the county recorder, or the escrow company. Those attending a closing may include
► the buyer;
► the seller;
► the real estate salespersons or brokers (both the buyer's and the seller's agents);
► the seller's and the buyer's attorneys;
► representatives of the lending institutions involved with the buyer's new mortgage loan, the buyer's assumption of the seller's existing loan, or the seller's payoff of an existing loan; and
► a representative of the title insurance company.

Closing agent or closing officer. One person usually conducts the proceedings at a closing and calculates the division of income and expenses between the parties (called settlement). In some areas, real estate brokers preside. In others, the closing agent is the buyer's or seller's attorney, a representative of the lender, or a representative of the title company. Some title companies and law firms employ paralegal assistants who conduct closings for their firms.

Preparation for closing involves ordering and reviewing an array of documents, such as the title insurance policy or title certificate, surveys, property insurance policies, and other items. Arrangements must be made with the parties for the time and place of closing. Closing statements and other documents must be prepared.

The exchange.
When the parties are satisfied that everything is in order, the exchange is made. All pertinent documents are then recorded in the correct order to ensure continuity of title. For instance, if the seller pays off an existing loan and the buyer obtains a new loan, the seller's satisfaction of mortgage must be recorded before the seller's deed to the buyer. The buyer's new mortgage or deed of trust must then be recorded after the deed because the buyer cannot pledge the property as security for the loan until he or she owns it.

Closing in Escrow
An escrow is a method of closing in which a disinterested third party is authorized to act as escrow agent and to coordinate the closing activities. The escrow agent also may be called the escrow holder. The escrow agent may be an attorney, a title company, a trust company, an escrow company, or the escrow department of a lending institution. Many real estate firms offer escrow services. However, a broker cannot be a disinterested party in a transaction from which he or she expects to collect a commission. Because the escrow agent is placed in a position of great trust, many states have laws regulating escrow agents and limiting who may serve in this capacity. Although a few states do not permit certain transactions to be closed in escrow, escrow closings are used to some extent in most states.

Escrow procedure.
When a transaction will close in escrow, the buyer and seller execute escrow instructions to the escrow agent after the sales contract is signed. One of the parties selects an escrow agent. Which party selects the agent is determined either by negotiation or by state law. Once the contract is signed, the broker turns over the earnest money to the escrow agent, who deposits it in a special trust, or escrow, account.

Buyer and seller deposit all pertinent documents and other items with the escrow agent before the specified date of closing.

The seller usually deposits
► the deed conveying the property to the buyer;
► title evidence (abstract and attorney's opinion, certificate of title, title insurance, or Torrens certificate);
► existing hazard insurance policies;
► a letter or mortgage reduction certificate from the lender stating the exact principal remaining (if the buyer assumes the seller's loan);
► affidavits of title (if required);
► a payoff statement (if the seller's loan is to be paid off); and
► other instruments or documents necessary to clear the title or to complete the transaction.

The buyer deposits
► the balance of the cash needed to complete the purchase, usually in the form of a certified check;
► loan documents (if the buyer secures a new loan);
► proof of hazard insurance, including (where required) flood insurance; and
► other necessary documents, such as inspection reports required by the lender.

The escrow agent has the authority to examine the title evidence. When marketable title is shown in the name of the buyer and all other conditions of the escrow agreement have been met, the agent is authorized to disburse the purchase price to the seller, minus all charges and expenses. The agent then records the deed and mortgage or deed of trust (if a new loan has been obtained by the purchaser).

If the escrow agent's examination of the title discloses liens, a portion of the purchase price can be withheld from the seller. The withheld portion is used to pay the liens to clear the title.

If the seller cannot clear the title, or if for any reason the sale cannot be consummated, the escrow instructions usually provide that the parties be returned to their former statuses, as if no sale occurred. The escrow agent reconveys title to the seller and returns the purchase money to the buyer.
 
Internal Revenue Service Reporting Requirements
Certain real estate closings must be reported to the Internal Revenue Service (IRS) on Form 1099-S. The affected properties include sales or exchanges of land (improved or unimproved), including air space;
► an inherently permanent structure, including any residential, commercial, or industrial building;
► a condominium unit and its appurtenant fixtures and common elements (including land); or
► stock in a cooperative housing corporation.

Information to be reported includes the sales price, the amount of property tax reimbursement credited to the seller, and the seller's Social Security number. If the closing agent does not notify the IRS, the responsibility for filing the form falls on the mortgage lender, although the brokers or the parties to the transaction ultimately could be held liable.

Broker's Role at Closing
Depending on local practice, the broker's role at closing can vary from simply collecting the commission to conducting the proceedings. Real estate brokers are not authorized to give legal advice or otherwise engage in the practice of law. This means that in some states, a broker's job is essentially finished as soon as the real estate sales contract is signed. After the contract is signed, the attorneys take over. Even so, a broker's service generally continues all the way through closing. The broker makes sure all the details are taken care of so that the closing can proceed smoothly. This means making arrangements for title evidence, surveys, appraisals, inspections or repairs for structural conditions, water supplies, sewerage facilities, or toxic substances.

Though real estate licensees do not always conduct closing proceedings, they usually attend. Often, the parties look to their agents for guidance, assistance, and information during what can be a stressful experience. Licensees need to be thoroughly familiar with the process and procedures involved in preparing a closing statement, which includes the expenses and prorations of costs to close the transaction. It is also in the brokers' best interests that the transactions they worked so hard to bring about move successfully and smoothly to a conclusion. Of course, a broker's (and a salesperson's) commission is generally paid out of the proceeds at closing.

IN PRACTICE      Licensees should avoid recommending sources for any inspection or testing services. If a buyer suffers any injury as a result of a provider's negligence, the licensee may also be liable. The better practice is to give clients the names of several professionals who offer high-quality services.

Lender's Interest in Closing
Whether a buyer obtains new financing or assumes the seller's existing loan, the lender wants to protect its security interest in the property. The lender has an interest in making sure the buyer gets good, marketable title and that tax and insurance payments are maintained. Lenders want their mortgage liens to have priority over other liens. They also want to ensure that insurance is kept up to date in case property is damaged or destroyed. For this reason, a lender generally requires a title insurance policy and a fire and hazard insurance policy (along with a receipt for the premium). In addition, a lender may require other information: a survey, a termite or another inspection report, or a certificate of occupancy (for a newly constructed building). A lender also may request that a reserve account be established for tax and insurance payments. Lenders sometimes even require representation by their own attorneys at closings.

 RESPA REQUIREMENTS
The federal Real Estate Settlement Procedures Act (RESPA) was enacted to protect consumers from abusive lending practices. RESPA also aids consumers during the mortgage loan settlement process. It ensures that consumers are provided with important, accurate, and timely information about the actual costs of settling or closing a transaction. It also eliminates kickbacks and other referral fees that tend to inflate the costs of settlements unnecessarily. RESPA prohibits lenders from requiring excessive escrow account deposits.

RESPA requirements apply when a purchase is financed by a federally related mortgage loan. Federally related loans means loans made by banks, savings and loan associations, or other lenders whose deposits are insured by federal agencies. It also includes loans insured by the FHA and guaranteed by the VA; loans administered by HUD; and loans intended to be sold by the lenders to Fannie Mae, Ginnie Mae, or Freddie Mac. RESPA is administered by HUD.

RESPA regulations apply to first-lien residential mortgage loans made to finance the purchases of one-family to four-family homes, cooperatives, and condominiums, for either investment or occupancy. RESPA also governs second or subordinate liens for home equity loans. A transaction financed solely by a purchase-money mortgage taken back by the seller, an installment contract (contract for deed), and a buyer's assumption of a seller's existing loan are not covered by RESPA. However, if the terms of the assumed loan are modified, or if the lender charges more than $50 for the assumption, the transaction is subject to RESPA regulations.

IN PRACTICE     While RESPA's requirements are aimed primarily at lenders, some provisions of the Act affect real estate brokers and agents as well. Real estate licensees fall under RESPA when they refer buyers to particular lenders, title companies, attorneys, or other providers of settlement services. Licensees who offer computerized loan origination (CLO) services also are subject to regulation. Remember: Buyers have the right to select their own providers of settlement services.

Controlled Business Arrangements
A service that is increasing in popularity is one-stop shopping for consumers of real estate services. A real estate firm, title insurance company, mortgage broker, home inspection company, or even a moving company may agree to offer a package of services to consumers. RESPA permits such a controlled business arrangement (CBA) as long as a consumer is clearly informed of the relationship among the service providers and that other providers are available. Fees may not be exchanged among the affiliated companies simply for referring business to one another. This may be a particularly important issue for licensees who offer cornputerized loan origination (CLO) services to their clients and customers (discussed in Chapter 15). While a borrower's ability to comparison shop for a loan may be enhanced by a CLO system, his or her range of choices must not be limited. Consumers must be informed of the availability of other lenders.

Disclosure Requirements
Lenders and settlement agents have the following disclosure obligations at the time of loan application and loan closing:
     ► Special information booklet. Lenders must provide a copy of a special informational HUD booklet to every person from whom they receive or for whom they prepare a loan application (except for refinancing). The HUD booklet must be given at the time the application is received or within three days afterward. The booklet provides the borrower with general information about settlement (closing) costs. It also explains the various provisions of RESPA, including a line-by-line description of the Uniform Settlement Statement.
     ► Good-faith estimate of settlement costs. No later than three business days after receiving a loan application, the lender must provide to the borrower a good-faith estimate of the settlement costs the borrower is likely to incur. This estimate may be either a specific figure or a range of costs based on comparable past transactions in the area. In addition, if the lender requires use of a particular attorney or title company to conduct the closing, the lender must state whether it has any business relationship with that firm and must estimate the charges for this service.
     ► Uniform Settlement Statement (HUD-1 Form). RESPA requires that a special HUD form be completed to itemize all charges to be paid by a borrower and seller in connection with settlement. The Uniform Settlement Statement includes all charges that will be collected at closing, whether required by the lender or another party. Items paid by the borrower and seller outside closing and not required by the lender are not included on the HUD-1 form. Charges required by the lender that are paid for before closing are indicated as "paid outside of closing" (POC). RESPA prohibits lenders from requiring borrowers to deposit amounts in escrow accounts for taxes and insurance that exceed certain limits, thus preventing the lenders from taking advantage of the borrowers. Sellers are also prohibited from requiring, as a condition of a sale, that the buyer purchase title insurance from a particular company. A copy of the HUD-1 form is illustrated later in this Chapter. (See Figure 22.4.)

The settlement statement must be made available for inspection by the borrower at or before settlement. Borrowers have the right to inspect a completed HUD-1 form, to the extent that the figures are available, one business day before the closing. (Sellers are not entitled to this privilege.)

Lenders must retain these statements for two years after the dates of closing. In addition, state laws generally require that licensees retain all records of a transaction for a specific period. The Uniform Settlement Statement may be altered to allow for local custom, and certain lines may be deleted if they do not apply in an area.
 
Kickbacks and referral fees.
RESPA prohibits the payment of kickbacks, or unearned fees, in any real estate settlement service. It prohibits referral fees when
no services are actually rendered. The payment or receipt of a fee, a kickback, or
anything of value for referrals for settlement services includes activities such as mortgage loans, title searches, title insurance, attorney services, surveys, credit reports, and appraisals.

 PREPARATION OF CLOSING STATEMENTS
A typical real estate transaction involves, in addition to the purchase price, expenses for both parties. These include items prepaid by the seller for which he or she must be reimbursed (such as taxes) and items of expense the seller has incurred, but for which the buyer will be billed (such as mortgage interest paid in arrears when a loan is assumed).

The financial responsibility for these items must be prorated (or divided) between the buyer and the seller. All expenses and prorated items are accounted for on the settlement statement. This is how the exact amount of cash required from the buyer and the net proceeds to the seller are determined. (See Figure 22.1.)

How the Closing Statement Works
The completion of a closing statement involves an accounting of the parties' debits and credits. A debit is a charge, that is, an amount that a party owes and must pay at closing. A credit is an amount entered in a person's favor—an amount that has already been paid, an amount being reimbursed, or an amount the buyer promises to pay in the form of a loan.

To determine the amount a buyer needs at closing, the buyer's debits are totaled. Any expenses and prorated amounts for items prepaid by the seller are added to the purchase price. Then the buyer's credits are totaled. These include the earnest money (already paid), the balance of the loan the buyer obtains or assumes, and the seller's share of any prorated items the buyer will pay in the future. (See Figure 22.2.) Finally, the total of the buyer's credits is subtracted from the total debits to arrive at the actual amount of cash the buyer must bring to closing. Usually, the buyer brings a cashier's or certified check.

A similar procedure is followed to determine how much money the seller will actually receive. The seller's debits and credits are each totaled. The credits include the purchase price plus the buyer's share of any prorated items that the seller has prepaid. The seller's debits include expenses, the seller's share of prorated items to be paid later by the buyer, and the balance of any mortgage loan or other lien that the seller pays off. Finally, the total of the seller's debits is subtracted from the total credits to arrive at the amount the seller will receive.

Broker's commission.
The responsibility for paying the broker's commission will have been determined by previous agreement. If the broker is the agent for the seller, the seller is normally responsible for paying the commission. If an agency agreement exists between a broker and the buyer, or if two agents are involved, one for the seller and one for the buyer, the commission may be apportioned as an expense between both parties or according to some other arrangement.