04 Title and Closing Costs (3)
credits
A credit is a positive balance or a positive amount. For our purposes, it is a figure entered in a party's favor when determining the overall costs associated with a transaction. On the Closing Disclosure, credits reflect expenses that have been paid by a particular individual or expenses that are owed to that individual.
debits
A debit is a negative balance or a negative amount. For the purposes of our discussion, a debit is an amount due from or owed by a particular individual when determining the overall costs associated with a transaction. On the Closing Disclosure, debits reflect charges made to the parties involved in the transaction. The actual amount that a buyer is to pay at closing is calculated by subtracting the buyer's total credits (such as prepaid earnest money or the balance of a loan that the buyer will assume from the seller) from the buyer's total debits (such as the purchase price). The remaining total is the amount that the buyer must bring to the closing to complete the transaction.
Credits and Debits
A debit to the buyer increases the amount due from the buyer at closing. A credit to the buyer decreases the amount due from the buyer at closing. A debit to the seller decreases the amount the seller receives at closing. A credit to the seller increases the amount the seller receives at closing. An easy example of a credit would be a buyer who prepays earnest money. Earnest money is a deposit made to a seller showing the buyer's good faith in regards to the future performance of a sales contract. In almost all instances, a buyer pays an earnest money deposit at the time the purchase contract is negotiated. So, at closing, the buyer receives a credit for the money that they already have prepaid. Seller's total credits - seller's total debits = what the seller receives
Prepaid Items
A prepaid item is an item that has been paid for ahead of time, generally by the seller. For example, a seller might have prepaid an insurance policy that is required by the local homeowner's association. A buyer must then generally "purchase" this item from the seller at the time of the sale, either with cash, credits, or in some other way that the principals have negotiated. Accrued items are generally debited to the seller and credited to the buyer. Prepaid items are credited to the seller and debited to the buyer.
Accrued Items
Accrued items are costs that have been incurred, but have not been paid for yet. Accrued costs are owed by a seller (such as some recurring special assessments and mortgage interest), but which will ultimately be paid by a buyer after they receive title to a property. That is to say, these expenses have been (or are being) incurred at the time of sale, but need not be paid at the time the sale closes. In an effort to ensure that these expenses are handled fairly, the seller generally pays the buyer for these items through credits at closing. For example, a seller might credit a buyer for the proportion of a special assessment that was charged during the part of the year that the seller occupied the property.
Lender-Related Closing Costs
Administration Fee: Additional fee sometimes charged by a lender to establish the loan. Appraisal Review Fee: Fee sometimes charged by a lender for a second appraiser to review the original appraisal when findings are considered questionable. Appraisal Fee: Fee paid to a licensed/certified real estate appraiser, usually by the lender, to appraise the value of the property. The appraisal fee varies, depending upon the value of the home and the difficulty involved in justifying value. Appraisal fees on VA and FHA loans are higher than on conventional loans because they require the appraiser to inspect items not strictly associated with value (but such inspections are not for the borrower and should not be substituted for an independent inspection done for a borrower before purchase, if the borrower so chooses). This fee is usually negotiated directly with the lender, who orders the appraisal. Assumption Fee: Fee charged by the lender for allowing the assumption of a loan by another party and forgiving the original borrower's obligation. Credit Report Fee: Fee paid to a credit reporting service for reviewing the borrower's credit history. Escrow Waiver Fee: Fee paid when an escrow account is not being established. Some states (including, Illinois, New York, Oregon, and the District of Columbia) have barred lenders from charging this fee, as it may violate the RESPA section disallowing parties from charging a fee for services that are not actually performed. Flood Certification Fee: Fee for a service hired to determine whether a property is located in a federally designated flood zone. Flood Monitoring: Fee paid to a service to maintain monitoring on whether flood remapping affects a property. Loan Origination Fee: The loan origination fee is often referred to as points. On an FHA loan, the loan origination fee is one point. On a VA loan, the loan origination fee is determined at the discretion of the lender. Anything in addition to one point (on government loans) is called discount points. A point is equal to one percentage point of the loan amount. This amount is paid directly to the lender as a fee to set up the loan. Mortgage Broker Fee: Broker processing fees. Sometimes there are several of these under different names since some brokers have other "fees" listed that are beyond the scope of this course, sometimes referred to as "junk fees" since the fee covers nothing but netting more money for the mortgage broker. Agents need to have their borrowers ask questions about this fee (or fees) to the broker directly since some of these are negotiable and can be reduced or eliminated. Tax Service Fee: Fee for a service that checks to make sure property tax payments are made or have been made. Underwriting Fee: Fee sometimes charged by lender if reselling the loan in the secondary market. Wire Transfer Fee: Fee charged if funds are wire transferred at closing for a buyer or seller. Warehousing Fee: Fee charged by lender as additional amount for establishing loan.
Net to Seller
After completing this chapter, it should be obvious that when a seller sells their property, they won't be pocketing the entire purchase price. The various closing costs that a seller incurs will decrease how much money the seller takes home. How much money the seller takes home is known as the net to seller. That's why, whether you're presenting one offer or several, an agent can present a net sheet to their client. A net sheet gives your client a good estimate of what they can expect to come away with after all closing costs are considered.
Buyer's Closing Costs
Appraisal fees: The party that ordered the appraisal usually pays the fees associated with that appraisal. Normally, this is paid by the buyer because it is required by the lender in order to get loan approval. Attorneys' fees: If a buyer is paying their attorneys out of their own pockets, then the attorneys' fees are often omitted from the closing statement. However, if one or more attorneys' fees are to be deducted from the proceeds from the closing, then the buyer will generally be debited for the attorney's fees. Condo or co-op fees: These are assessments that are used to help pay for maintenance of common areas and other co-op- or condo-related items. The buyer might owe the seller an adjusted amount based on the time the buyer uses the services. Loan fees: A buyer is usually responsible for paying loan origination fees for a new loan, and for paying assumption fees if they assume the seller's existing loan. But if a seller is paying off a mortgage before its due date, they may be required to pay a prepayment fee. Survey fees: A buyer usually pays property survey fees, especially if they obtain a new mortgage. If all parties agree, then a previous survey may be used as long as the seller can produce the old survey and signs a statement that, to the best of their knowledge, nothing has changed since the survey was done. The buyer's attorney and the lender do not have to accept the old survey. But, the parties might call for a recertification of the old survey by the surveyor, which is a common procedure. Tax and insurance reserves: A buyer is often required to open an escrow account to cover real estate taxes that are assessed during the time the transaction is taking place. In this case, they generally deposit at least enough in the account to pay for the taxes through the end of the month of closing. However, a seller is debited and a buyer is credited for any of the seller's unpaid taxes. A buyer often also pays at least the first year's premium on fire or hazard insurance at closing. Title expenses: There are two types of title insurance policies: lender's (mortgage loan) policies, and owner's (fee or purchase) policies. The homebuyer is generally responsible for paying for both policies.
Seller's Closing Costs
Attorneys' fees: Just like the buyer, if a seller is paying their attorneys out of their own pockets, then the attorneys' fees are often omitted from the closing statement. However, if one or more attorneys' fees are to be deducted from the proceeds from the closing, then the seller will generally be debited for the attorney's fees. Broker's commission: A commission is usually paid out as a percentage of the property's sales price: It is a seller's cost. The agreed-upon commission percentage will be explicitly stated in the sales contract. Condo or co-op fees: These are assessments that are used to help pay for maintenance of common areas and other co-op- or condo-related items. Before the closing, a seller must bring their account up to date. We'll talk more about these fees in our later level on condos and co-ops. Recording expenses: A seller is generally responsible for recording expenses (i.e., filing fees and other similar costs) related to clearing defects from the property's title, such as recording satisfactions of liens, affidavits, and quitclaim deeds. A buyer is usually responsible for the recording expenses associated with the title transfer, such as the costs associated with publicly recording the deed that gives them title. Satisfying existing liens: A seller will need to take on the expense of satisfying any existing lien on the property. In most cases, there is at least a mortgage lien that the seller will pay off with a portion of the buyer's lender's funds. Title expenses: Generally, a seller is required to pay for the title search (but not the policy). However, if a buyer conducts another search of their own, then they usually pay for that additional research. In some transactions the seller pays for the owner's policy while the buyer pays for the mortgagee's policy. But, remember this is always negotiable between the buyer and seller and is addressed in the sales contract. Transfer tax: Transfer taxes are usually a seller's responsibility.
Additional Transaction Fees
Certain kinds of financing can result in additional transaction costs. These expenses include the following: If a loan requires private mortgage insurance, then it is usually rolled into the loan's balance and paid as part of your monthly mortgage payment. If a loan is FHA-insured, a buyer is usually debited for the mortgage insurance premium unless it is financed with the loan. If a loan is a Veterans Affairs loan, the buyer is debited for a funding fee to the VA.
proration
In an exchange of the ownership of a property, proper division of ongoing expenses should be addressed. Some expenses, like HOA dues, are paid at the first of the year. Others, like mortgage interest, might be paid at the end of the year (in arrears). In every case, these expenses need to be split fairly between the buyer and seller of the property. This is done through a process known as proration.
Additional Guidelines for Calculating Prorated Expenses
In many states, the seller is held responsible for any expenses incurred on the closing date. However, some states (including New York) specify that the buyer owns the property as of the closing date, and they are, therefore, held responsible for any expenses incurred on that date. Estimates of utility charges and other similar expenses are often based on the most recent bill. Rents are usually prorated using a 365-day year, which reflects the actual number of days for which rent is collected. The seller generally receives rents that are due as of the closing date. But again, you should check your local laws to be certain of the regulations in your area. Security deposits are usually transferred from the seller to the buyer; these funds are held in trust for tenants and are not properly understood to be either the seller's or the buyer's property. Expenses like water and utilities, mortgage interest, and real estate taxes are frequently prorated using the 360-day banking year. However, some areas require that the 365-day year be used. Familiarize yourself with local laws, and contact local lenders to determine the standards they use when calculating prorated expenses. Some special assessments are billed in installments (such as assessments for sewer improvements). When a transaction involves expenses of this sort, the buyer often assumes all future payments with interest. This amount is not generally prorated at closing.
Home-Purchase-Process Closing Costs
Non-recurring closing costs associated with the home purchase process (and NOT the lender) include: Closing/escrow/settlement fee: Fee paid to the settlement agent or escrow holder. Courier fee: The costs associated with delivering documents to the buyer, seller, lender, title company, law firm, county recorder, and so on to facilitate the closing process. Home inspection fee: Fee a home buyer must pay if they did not pay it at the time the home was inspected. Homeowners' Association transfer fee: Fee charged by a homeowners' association for transferring all of their ownership documents to the new owner. Home warranty: Optional fee paid for an insurance policy covering items such as major appliances; not to be confused with a warranty provided by the builder of a new home that would cover the structure itself. Legal or document preparation fee: Fee paid to a lawyer or law firm for preparation of legal documents for transaction and lender-required forms. May also be paid to the lender for documents prepared in house. Notary fees: Fee for forms that must be attested to, or notarized. Option fee: A negotiated fee paid by the potential purchaser at the time of contracting for an option to terminate the contract for so many days, as spelled out in the earnest money contract. Pest inspection/treatment: Fee for inspection or treatment and repairs of pest infestations, wood rot, and water damage (as a lender may require as a precondition of procuring the loan). Recording Fees: Fee for recording legal documents with a local county recorder. Title insurance: Assurance to the potential homeowner that they are receiving clear title to the property being purchased—free of liens and encumbrances, as well as discrepancies in boundaries and area, if a survey was done. It is a one time payment.
Non-Recurring Closing Costs
Non-recurring closing costs may be divided into two categories: Those that are associated with the home-purchase process, such as title and inspection fees Those that are associated with the lender, such as the loan origination fee
New York City's Transfer Tax
Note: Additional transfer taxes must be paid within New York City. If the value of the property is $500,000 or less, the rate is 1% of the price. If the value of the property is more than $500,000, the rate is 1.425%.
reconciliation
Once all prorations, debits, and credits are known, they will be factored from the purchase price to determine how much money the buyer must bring to closing and how much the seller will be receiving at closing. This process of verifying that the Closing Disclosure correctly assesses these costs is known as reconciliation.
New York State's Transfer Tax
Sellers are traditionally responsible for paying the transfer tax, except for new construction. As I explained a couple of chapters ago, the New York real estate transfer tax applies to real property sale or transfer of more than $25,000. The tax is computed at a rate of two dollars for each $500 of consideration. Or, to make things easier, $4 of each $1,000. And there is an additional real estate transfer tax (sometimes referred to as the "mansion tax") of 1% of the sale price that applies to residences where consideration is $1 million or more.
Allocating Expenses (The title company will use the sales contract to determine how the parties have agreed to allocate the expenses.)
There are a variety of expenses associated with any real estate transaction. For example, brokers' commissions must be paid, and loans often come with significant fees. These expenses can be divided in various ways between the principals involved in the transaction. Their legal responsibility varies from state to state, and many expenses can be negotiated between the principals. These variables mean that there is no single set of general guidelines that can teach a license holder how these expenses are divided between principals. The closing attorney will use the sales contract to determine how the parties have agreed to allocate the expenses.
Prorated Expenses
There are many different expenses that might need to be prorated at closing. These can include: Real estate taxes Special assessments (a government-levied charge to a geographic area to fund a public project) HOA dues Fuel Water and sewer charges Rent (if a rental property is being sold) Security deposits Homeowners insurance will not be prorated, as a new policy will most likely be taken out by the buyer.
Calculating Prorated Expenses
When calculating prorated expenses, the first step is determining an annual charge for the item being prorated. This amount is then divided by 12 to calculate the monthly charge for the item. It may be necessary to go further and calculate a daily charge for the item. In this case, there are two methods commonly used to calculate daily charges: A 360-day year: The 360-day year is known as a "banker's year"; it is commonly used in banking to make calculations easier. That way the year is cleanly divided into 12 months of 30 days each. To figure daily charges using a 360-day year, you can divide the yearly charge by 360 or divide the monthly charge by 30. A 365-day year: The 365-day year is sometimes also called the "conventional calendar year," because its divisions reflect the actual months of the calendar that most of us use. To calculate the daily charge for an item using the conventional calendar year, divide the yearly charge by 365 (366 in a leap year). Before you begin calculating prorations, then, you will need to answer the following questions: What kind of item is being prorated? Is the charge for the item assessed daily, monthly, annually, or according to some other schedule? Is this item accrued or prepaid? Which calculation method should be used? Where is my calculator?
Closing Disclosure
a closing statement is a document that provides a detailed list of each party's expenses as well as how much they have already contributed to the transaction thus far. The specific document that will be used for mortgage loans is known as a Closing Disclosure. The closing statement also provides an accounting of the final amount that the buyer must bring to the closing. To complete a closing or settlement statement properly, one must know which principal is responsible for each transaction expense. Most closing cost expenses are agreed to in the sales contract. A license holder must also have a clear understanding of credits and debits and should know how to prorate expenses that must be divided between the principals.
