unit 23

Closing in Escrow

Although a few states prohibit transactions that are closed in escrow, escrow closings are used to some extent in most states. 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 real estate licensee cannot be a disinterested party in a transaction from which he 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

Title Procedures

Both the buyer and the buyer's lender will want assurance that the seller's title complies with the requirements of the sales contract. Additionally, lenders require title insurance in the event any "clouds" on the title (encumbrances on the real estate or claims on the title) should come up during the course of ownership. The title insurance is not issued until it is clear that such encumbrances from the past are unlikely. A major goal of title procedures is for the new owner to obtain a clear and valid "owner's title policy." Such a policy comes as close as any document can to providing evidence of ownership of a property that is unencumbered by any past liens or potential claims. As a first step toward a new owner's title policy, prior to closing and establishment of the new owner's title, the seller usually is 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. In Illinois, title commitments are usually used and provided by the title companies or its agents. 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 usually are 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 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 statements in the affidavit are incorrect. In 2010, the Title Insurance Act was amended by prohibiting title insurance companies, title insurance agents, or independent escrowees from making disbursements out of a fiduciary trust account in connection with any escrows, settlements, or closings unless the funds are collected or are good funds. This applies to $50,000 or less from any single party to a transaction or an aggregate amount of $50,000 or greater received from any single party to a transaction. "Good funds" which are required by the Title Insurance Act, are in one of the following forms: • Lawful money of the United States • Wired funds unconditionally held by the title insurance company, the title insurance agent, or independent escrowee • Cashier's checks, certified checks, bank money orders, official bank checks, or teller's checks drawn on or issued by a financial institution chartered under the laws of any state of the United States and unconditionally held by the title insurance company, title insurance agent, or independent escrowee • A personal check or checks in an aggregate amount not exceeding $5,000 per closing, provided that the title insurance company, title insurance agent, or independent escrowee has reasonable grounds to believe that sufficient funds are available for withdrawal in the account upon which the check is drawn at the time of disbursement • A check drawn on the trust account of any lawyer or real estate broker licensed under the laws of any state, provided that the title insurance company, title insurance agent, or independent escrowee has reasonable grounds to believe that sufficient funds are available for withdrawal in the account upon which the check is drawn at the time of disbursement • A check issued by Illinois or the United States • A check drawn on the fiduciary trust account of a title insurance company or title insurance agent, provided that the title insurance company, title insurance agent, or independent escrowee has reasonable grounds to believe that sufficient funds are available for withdrawal in the account upon which the check is drawn at the time of disbursement Collected funds means funds deposited, finally settled, and credited to the title insurance company, title insurance agent, or independent escrowee's fiduciary trust account. Whether 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 (also called an estoppel certificate or certificate of no defense) 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. Once the borrower has executed the estoppel certificate, the borrower cannot thereafter claim that he did not owe the amount indicated in the payoff or estoppel certificate. The same procedure would be 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 customarily are closed through an escrow. 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. Licensees often assist in pre-closing 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, licensees have a statutory duty to coordinate and supervise closing activities. Aside from state laws on this issue, a licensee without a specific role in the closing may still be the person with the most knowledge about the transaction. Because of this, many licensees feel it is part of their fiduciary duty to be present at a face-to-face closing.

Final property inspection

In the real estate contract, the buyer usually reserves the right to make a final inspection, often referred to as a walk-through, shortly before the closing takes place. Accompanied by the licensee, the buyer verifies that necessary repairs have been made, that the property has been well maintained, that all fixtures are in place, and that no unauthorized removal or alteration of any part of the improvements has taken place. It is not an opportunity to reopen negotiations.

Disclosure Requirements

Lenders and settlement agents have the following disclosure obligations at the time of loan application and loan closing or within three business days of receiving the loan application. If the lender denies the loan within three days, then RESPA does not require that the lender provide the following documents

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, 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.

Sample proration calculation

Assume a sale is to be closed on September 17. Current real estate taxes of $1,200 are to be prorated. A 360-day year is used. The accrued period, then, is 8 months and 17 days. First determine the prorated cost of the real estate tax per month and day: 12 months / $1,200 = $100/month $100 / 30 days = $3.333 per day Next, multiply these figures by the accrued period and add the totals to determine the prorated real estate tax: $100 x 8 months = $800 $3.333 x 17 days = $56.661 $800 + $56.661 = $856.661 Thus, the accrued real estate tax for 8 months and 17 days is $856.66 (rounded off to two decimal places after the final computation). This amount represents the seller's accrued earned tax. It will be a credit to the buyer and a debit to the seller on the closing statement. To compute this proration using the actual number of days in the accrued period, the following method is used: The accrued period from January 1 to September 17 runs 260 days (January's 31 days plus February's 28 days and so on, plus the 17 days of September). $1,200 tax bill ÷ 365 days = $3.288 per day $3.288 × 260 days = $854.880, or $854.88 While these examples show proration as of the date of settlement, the agreement of sale may require otherwise. For instance, a buyer's possession date may not coincide with the settlement date. In this case, the parties could prorate according to the date of possession.

Buyer's Issues

Both the buyers and their lenders must be sure that the seller can deliver the title that was promised in the purchase agreement and that the property is now in essentially the same condition it was in when the buyers and the sellers agreed to the sale. 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. Although the For Your Protection: Get a Home Inspection pamphlet is required only for FHA loans, the information is valuable for all buyers. The pamphlet emphasizes the difference between an appraisal and a home inspection.

Real Estate Settlement Procedures Act (RESPA)

The Real Estate Settlement Procedures Act (RESPA) is a federal consumer law that requires certain disclosures about the mortgage and settlement process and prohibits certain practices that increase the costs of settlement services, such as kickbacks and referral fees that can increase settlement costs for home buyers. RESPA regulations apply to first-lien residential mortgage loans made to finance the purchases of one- to four-family homes, cooperatives, and condominiums, for either investment or occupancy, as well as second or subordinate liens for home equity loans when a purchase is financed by a federally related mortgage loan. Federally related loans are those made by banks, savings and loan associations, or other lenders whose deposits are insured by federal agencies; loans insured by the FHA and guaranteed by the Department of Veterans Affairs (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 does not apply to the following settlements: • Loans on large properties (i.e., more than 25 acres) • Loans for business or agricultural purposes • Construction loans or other temporary financing • Vacant loans on large properties (i.e., more than 25 acres) • Loans for business or agricultural purposes • Construction loans or other temporary financing • Vacant land (unless a dwelling will be placed on the lot within two years) • A transaction financed solely by a purchase-money mortgage taken back by the seller • An installment contract (contract for deed) • A buyer's assumption of a seller's existing loan (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.) RESPA prohibits certain practices that increase the cost of settlement services: • Section 8 prohibits kickbacks and fee-splitting for referrals of settlement services and unearned fees for services not actually performed. Violations are subject to criminal and civil penalties, including fines up to $10,000 and/or imprisonment up to one year. Consumers may privately pursue a violator in court; the violator may be liable for an amount up to three times the amount of the charge paid for the service. • Section 9 prohibits home sellers from requiring that homebuyers buy title insurance from a particular company. Buyers may sue the seller for such a violation; violators are liable for up to three times the amount of all charges paid for the title insurance. • Section 10 prohibits lenders from requiring excessive escrow account deposits, money set aside to pay taxes, hazard insurance, and other charges related to the property. Sweeping changes required 2015, include the mandatory use of the new Settlement Statement instead of the previously used HUD-1 Closing Statement on most closings involving a federally insured mortgage. Although the burden of implementing the new reforms is the responsibility of the lender, real estate licensees should be aware of the requirements because failure to meet the standards can and will delay closings

Survey

A survey provides information about the exact location and size of the property. The sales contract specifies who will pay for the survey. Typically, the survey indicates the location of all buildings, driveways, fences, and other improvements located on the premises. Any improvements located on adjoining property that may encroach on the premises being bought also will 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. Relying on old surveys is not advised and typically not allowed by lenders; the property should be re-surveyed by a competent surveyor, whether or not the title company or lender requires it. A current survey confirms that the property purchased is exactly what the buyer wants

Closing agent or closing officer

A closing agent may be a representative of the title company, the lender, the real estate broker, or the buyer's or seller's attorney. Some title companies and law firms employ paralegal assistants who conduct closings for their firms. The closing agent orders and reviews the title insurance policy or title certificate, surveys, property insurance policies, and other items. After reviewing the agreement of sale (purchase agreement), the agent prepares a closing statement indicating the division of income and expenses between the parties. Finally, the time and place of closing must be arranged. When the parties are satisfied that everything is in order, the exchange is made. The seller delivers the signed deed to the buyer, who accepts it. 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 be recorded after the deed because the buyer cannot pledge the property as security for the loan until he owns it

Closing Statement

A couple lists their home at 123 Main Street in Chicago with a real estate brokerage. The listing price is $237,000, and possession will take place within two weeks after all parties have signed the contract. Under the terms of the listing agreement, the sellers agree to pay the licensee a commission of 6 percent of the sales price.

Prepaid Items

A tax proration could be a prepaid item in some locations. Because real estate taxes may be paid in the early part of the year, a tax proration calculated for a closing that takes place later in the year must reflect that the seller has already paid the tax. For example, in the preceding problem, suppose that all taxes had been paid. The buyer, then, would have to reimburse the seller; the proration would be credited to the seller and debited to the buyer. In figuring the tax proration, it is necessary to ascertain the number of future days, months, and years for which taxes have been paid. The formula commonly used for this purpose is as follows: With this formula (using the statutory-month method), we can find the amount the buyer will reimburse the seller for the portion of the real estate tax already paid for time the buyer will live in the house. The prepaid period, as determined using the formula for prepaid items, is 3 months and 13 days. Three months at $100 per month equals $300, and 13 days at $3.333 per day equals $43.329. Add days and months to arrive at $343.329, or $343.33 credited to the seller and debited to the buyer. Where taxes are paid in arrears (2011is paid in 2012), as in Illinois, the roles reverse (buyer credit, seller debit), but the math is essentially the same

Additional fees

An FHA borrower owes a lump sum for payment of the mortgage insurance premium (MIP) if it is not financed as part of the loan. A VA mortgagor pays a funding fee directly to the VA at closing. If a conventional loan carries private mortgage insurance, the buyer prepays one year's insurance premium at closing.

IRS 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 • shares 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 real estate licensees or the parties to the transaction ultimately could be held liable

Licensee's Role at Closing

Depending on local practice, the licensee's role at closing can vary from simply collecting the commission to conducting the proceedings. Real estate licensees are not authorized to give legal advice or otherwise engage in the practice of law. This means that in some states, a licensee's job is essentially finished as soon as the sales contract is signed. After the contract is signed, the attorneys take over. Even so, a licensee's service generally continues all the way through closing because it is in the licensee's best interest that the transactions move successfully and smoothly to a conclusion. This may mean actively arranging for title evidence, surveys, appraisals, and inspections or repairs for structural conditions, water supplies, sewage 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. 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 might also be named in any lawsuit. The better practice is to give clients the names of several professionals who offer high-quality services. In addition, licensees who receive any compensation or reward from a source they recommend to a client must disclose such an arrangement to the client. Licensees must never receive compensation from an attorney or a lender

Attorney's fees

If either of the parties' attorneys will be paid from the closing proceeds, that party will be charged with the expense in the closing statement. This expense may include fees for the preparation or review of documents or for representing the parties at settlement.

Face-to-Face Closing

Face-to-face closings may be held at a number of locations, including the offices of the title company, the lending institution, an attorney for one of the parties, the broker, the county recorder, or the escrow company. Those attending a closing may include • the buyer or the buyer's duly authorized agent; • the seller or the seller's duly authorized agent; • the real estate licensees (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.

Loan fees

For a new loan, the lender generally charges an origination fee and possibly discount points if the borrower wants a below-market interest rate. These lender charges for taking, underwriting, and processing the loan application, including points and origination fees, may not increase prior to closing. If they do, the lender may elect to reissue a new GFE, thereby triggering a three-day waiting period to closing (to allow the buyer time to "shop" for a new loan) or to "correct" the problem with a reimbursement within 30 days of closing. If the buyer assumes the seller's existing financing, the buyer may be required to pay an assumption fee. Also, under the terms of some mortgage loans, the seller may be required to pay a prepayment charge or penalty for paying off the mortgage loan before its due date

Closing

In Illinois, the closing statement is customarily prepared by the buyer's lender, the lender's agent (usually a title insurance company), or the seller's lawyer. Although real estate licensees are prohibited from completing formal closing statements as a result of the Illinois Supreme Court's decision in Chicago Bar Association, et al., v. Quinlan and Tyson, Inc., estimated statements are often needed when preparing a comparative market analysis (CMA), when filling out an offer for a buyer, or when presenting an offer to a seller. For this reason, licensees must understand the preparation of a closing statement, which includes the expenses and prorations of costs to close the transaction.

Proration of Expenses/Taxes

Most closings involve the division of financial responsibility between the buyer and seller for such items as loan interest, taxes, rents, fuel, and utility bills. These allowances are called prorations. Prorations are necessary to ensure that expenses are divided fairly between the seller and the buyer. For example, the seller may owe current taxes that have not been billed; the buyer would want this settled at the closing. Where taxes must be paid in advance, the seller is entitled to a rebate at the closing. If the buyer assumes the seller's existing mortgage or deed of trust, the seller usually owes the buyer an allowance for accrued interest through the date of closing. Accrued items such as water bills, Illinois real estate taxes, and interest on an assumed mortgage that is paid in arrears are expenses to be prorated that are owed by the seller but later will be paid by the buyer. The seller therefore pays for these items by giving the buyer credits for them at closing. Prepaid items, such as monthly assessments, are expenses to be prorated that have been prepaid by the seller but not fully used up. They are therefore credits to the seller. Accurate prorating involves four considerations: • Nature of the item being prorated • Whether it is an accrued item that requires the determination of an earned amount • Whether it is a prepaid item that requires the determination of an unearned amount (that is, a refund to the seller) • What arithmetic processes must be used The computation of a proration involves identifying a yearly charge for the item to be prorated, then dividing by 12 to determine a monthly charge for the item. Usually, it is also necessary to identify a daily charge for the item by dividing the monthly charge by the number of days in the month. These smaller portions then are multiplied by the number of months or days in the prorated time period to determine the accrued or unearned amount that will be figured in the settlement. Using this general principle, there are two methods of calculating prorations: • The yearly charge is divided by a 360-day year (commonly called a statutory or banking year), or 12 months of 30 days each. • The yearly charge is divided by 365 (366 in a leap year) to determine the daily charge. Then the actual number of days in the proration period is determined, and this number is multiplied by the daily charge. A third method, the statutory month variation, is also acceptable in Illinois. In this method, the yearly charge is divided by 12 to determine a monthly amount. The monthly charge then is divided by the actual number of days in the month in which the closing occurs. This final number is the daily charge for that month. The final proration figure will vary slightly, depending on which computation method is used. The final figure also varies according to the number of decimal places to which the division is carried. All of the computations in this unit are computed by carrying the division to three decimal places. The third decimal place is rounded off to cents only after the final proration figure is determined. When the real estate tax is levied for the calendar year and is payable during that year or in the following year, the accrued portion is for the period from January 1 through the date of closing. If the current tax bill has not yet been issued, the parties must agree on an estimated amount based on the previous year's bill and any known changes in assessment or tax levy for the current year.

Escrow or impound accounts

Most mortgage lenders require that borrowers provide reserve funds or escrow accounts to pay future real estate taxes and insurance premiums. A borrower starts the account at closing by depositing funds to cover at least the amount of unpaid real estate taxes from the date of lien to the end of the current month. (The buyer receives a credit from the seller at closing for any unpaid taxes.) Afterward, an amount equal to one month's portion of the estimated taxes is included in the borrower's monthly mortgage payment. The borrower is responsible for maintaining adequate fire or hazard insurance as a condition of the mortgage loan. Generally, the first year's premium is paid in full at closing. An amount equal to one month's premium is paid after that. The borrower's monthly loan payment includes the principal and interest on the loan, plus one-twelfth of the estimated taxes and insurance (PITI). The taxes and insurance are held by the lender in the escrow or impound account until the bills are due. RESPA permits lenders to maintain a cushion equal to one-sixth of the total estimated amount of annual taxes and insurance. However, if state law or mortgage documents allow for a smaller cushion, the lesser amount prevails

Transfer tax

Most states require some form of transfer tax, conveyance fee, or tax stamps on real estate conveyances. This expense is most often borne by the seller, although customs vary. In addition, many cities and local municipalities charge transfer taxes. Responsibility for these charges varies according to local practice. In Illinois, state and county transfer taxes are usually paid by the seller in accordance with most sales contracts. Local ordinances usually establish which party is responsible for paying municipal transfer taxes.

Seller's Issues

Naturally, the seller's main interest is to receive payment for the property. Sellers want to be sure that the buyer has obtained the necessary financing and has sufficient funds to complete the sale. Sellers will also want to be certain that they have 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. Licensees should discuss with clients the approximate expenses involved in closing at the time the listing agreement or buyer agency agreement is entered into but not later than the time when the sales contract is signed

The offer to purchase

On May 18, the real estate brokerage company submits a contract offer to the seller from the buyer, who resides at 22 King Court, Riverdale. The buyer offers $230,000, with earnest money and down payment of $46,000. The buyer expects to obtain a conventional 30-year fixed-rate mortgage for 80 percent of the purchase price and, therefore, will not need private mortgage insurance (PMI). The seller accepts the buyer's offer on May 29, with a closing date of June 15. In this real estate transaction, taxes are paid in arrears. Taxes for this year, estimated at last year's figure of $3,450, have not been paid. According to the contract, prorations will be made on the basis of 30 days in a month.

Mortgage loan interest

On almost every mortgage loan the interest is paid in arrears, so buyer and seller must understand that the mortgage payment due on June 1, for example, includes interest due for the month of May. Thus, the buyer who assumes a mortgage on May 31 and makes the June payment pays for the time the seller occupied the property and should be credited with a month's interest. On the other hand, the buyer who places a new mortgage loan on May 31 may be pleasantly surprised to hear that he will not need to make a mortgage payment until a month later. The terms of some assumed mortgage loans provide that interest is charged at the beginning of the month (in advance); without this provision, interest is always charged at the end of the month (in arrears). When the interest on the existing mortgage to be assumed by the buyer is charged at the beginning of the month, the unearned portion (that is, the part that is prepaid from the date of closing to the end of the month) must be credited to the seller and debited to the buyer. When the mortgage interest is charged at the end of the month, the earned portion of the mortgage interest through the date of closing is an accrued expense, debited to the seller and credited to the buyer.

Sample prepaid item calculation

One example of a prepaid item is a water bill. Assume that the water is billed in advance by the city without using a meter. The six months' billing is $60 for the period ending October 31. The sale is to be closed on August 3. Because the water bill is paid to October 31, the prepaid time must be computed. Using a 30-day basis, the time period is the 27 days left in August plus 2 full months: $60 ÷ 6 = $10 per month. For one day, divide $10 by 30, which equals $0.333 per day. The prepaid period is 2 months and 27 days, so This is a prepaid item; it is credited to the seller and debited to the buyer on the closing statement. To figure this based on the actual days in the month of closing, the following process would be used

Real estate taxes

Proration of real estate taxes varies, depending on how the taxes are paid in the area where the real estate is located. In some states, real estate taxes are paid in advance; that is, if the tax year runs from January 1 to December 31, taxes for the coming year are due on January 1. In this case, the seller, who has prepaid a year's taxes, should be reimbursed for the portion of the year remaining after the buyer takes ownership of the property. In other areas, taxes are paid in arrears, on December 31 for the year just ended. In this case, the buyer should be credited by the seller for the time the seller occupied the property. Sometimes, taxes are due during the tax year, partly in arrears and partly in advance; sometimes they are payable in installments. It gets even more complicated if city, state, school, and other property taxes start their tax years in different months. Whatever the case may be in a particular transaction, the licensee should understand how the taxes will be prorated. Taxes in Illinois are paid in arrears. The buyer must be credited for any taxes that still will be paid in the future for time in the "past" (i.e., up until closing) when the seller occupied the property. If an unpaid installment based on last year has been billed, this specific amount is credited to the buyer and debited to the seller. The buyer must be credited with the current year's taxes to time of closing because those taxes will not be paid until next year (again by the buyer/new owner). Consequently, the seller is debited accordingly, to the date of close, and a proration (and often a tax estimate based on last year's tax) is necessary for this latter figure. The following formula may be used in Illinois: Last annual tax bill ÷ 360 × Number of days from January 1 to closing date = Tax proration: the amount seller owes buyer.

Uniform Settlement Statement

RESPA requires that the Uniform Settlement Statement itemize all charges that are normally paid by a borrower and a seller in connection with settlement, whether required by the lender or another party, or paid by the lender or any other person. Charges required by the lender that are paid before closing are indicated as paid outside of closing (POC). Lenders are permitted to "correct" any violation of the tolerances by reimbursing the borrower within 30 days of settlement. 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. While RESPA does not require that escrow accounts be set up, certain government loan programs and some lenders require escrow accounts as a condition of the loan. RESPA places limits on the amounts that a lender may require: on a monthly basis, the lender may require only one-twelfth of the total of the disbursements for the year, plus an amount necessary to cover a shortage in the account. No more than one-sixth of the year's total disbursements may be held as a cushion (a cushion is not required). Once a year, the lender must perform an escrow account analysis and return an amount over $50 to the borrower. By law, borrowers have the right to inspect a completed settlement statement 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 closing date. In addition, state laws generally require that licensees retain all records of a transaction for a specific period. New laws also require the lender to provide a Loan Estimate within three business days of when the borrower applies for a loan, and prior to closing, a lender must provide the Closing Disclosure, or CD, at least three business days prior to closing.

Title expenses

Responsibility for title expenses varies according to local custom. In most areas, the seller is required to furnish evidence of good title and pay for the title search. If the buyer's attorney inspects the evidence or if the buyer purchases a title insurance policy, the buyer is charged for the expense. Because the seller usually is required by the contract to furnish evidence of good title, the seller customarily pays for the owner's title insurance policy. The buyer customarily pays for the lender's policy, which ensures that the lender has a valid first lien.

Mortgage Disclosure Improvement Act

Since its effective date of July 31, 2009, the Mortgage Disclosure Improvement Act (MDIA) has changed how buyers and sellers, lenders, mortgage brokers, title agents, and real estate licensees prepare for a closing. The timeliness of certain disclosures now affects the date of closings. Lenders and licensees should keep in mind the numbers 3, 7, and 3: • 3 business days from application to provide the truth-in-lending statement (TIL) and good-faith estimate (GFE) • 7 business days before the signing of loan documents, after the borrower receives the final truth-in-lending statement and good-faith estimate • 3 business days to wait for closing if the APR has changed more than 0.125 percent from the original or most recent TIL and GFE Until the applicant/borrower receives the GFE and the TIL, the lender may collect only a reasonable fee for accessing the applicant's credit history. Plus, the Home Valuation Code of Conduct (HVCC) requires that the borrower be provided with a copy of the home's appraisal within three business days of closing. Lenders must provide a statement to the applicants indicating that they are not obligated to complete the transaction simply because disclosures were provided or because they applied for a loan. If the annual percentage rate increases more than 0.125 percent from the original TIL, then creditors must provide new disclosures with a revised annual percentage rate (APR) and then wait an additional three business days before closing the loan. Consumers are permitted to accelerate the process if a personal emergency, such as a foreclosure, exists. The intent of this law is to prevent consumers from receiving an enticing low rate at the initial application and then learning at settlement that the lender is charging more in fees. Licensees should encourage their buyers to discuss all loan options with their lenders before signing a contract so that lenders can provide the disclosures in a timely fashion. Borrowers should lock in interest rates with a date that is about ten days from an anticipated settlement. Any change to the interest rate, loan amount, loan product, or lender's or escrow fees can affect the APR, which may then require a redisclosure. Redisclosures can potentially delay settlement. Before closing, everyone involved in the real estate transaction should check and double-check that the Closing Disclosure and other settlement forms are consistent with the original application. No one—buyers, sellers, or real estate agents—should schedule closings that do not account for the seven-day waiting period.

The buyer's loan application

The buyer's new loan is for $184,000. The buyer is offered three interest rate options: 4.5 percent with 2 points, 5 percent with 1 point, or 6 percent with ½ point. The rate options would be listed on page 3 of the good-faith estimate. The buyer's locked-in rate of 6 percent is good until 4 pm June 20th. The buyer will pay interest on the loan for the remainder of the month of closing: 15 days at $25.56 per day ($383.40). The first full payment, including July's interest, will be due on August 1. The loan origination fee is $2,300 and 1 discount point ($1,840). In connection with this loan, the buyer must provide a flood certification ($12), a survey ($395), and a pest inspection ($65). In connection with this loan, the buyer will be charged $500 to have the property appraised. The buyer is only charged for the credit report at the time of loan application, but the appraisal fee must be paid upon loan approval and before closing. Both items are noted as POC on the settlement statement. The cost of a one-year hazard insurance policy is $3 per $1,000 of appraised value ($230,000 ÷ 1,000 × 3 = $690) and will be paid at closing to the insurance company. The lender requires a reserve account for property taxes and insurance. The buyer's initial deposit is 7/12 of the anticipated county real estate tax of $3,450 ($2,012.50) and two months of the insurance policy ($115). The lender requires that 1/12 of the annual insurance premium ($57.50) and taxes ($287.50) be included in the monthly payment.

How the Closing Statement Works

The completion of a closing statement involves an accounting of the parties' debits and credits. A debit 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. The buyer's credits are then 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. 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 actually will 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.

Computing the prorations and charges

The following list illustrates the various steps in computing the prorations and other amounts to be included in the settlement to this point: • Closing date: June 15 • Commission: 6% (0.06) × $230,000 sales price = $13,800 • Seller's mortgage interest: 7% (0.07) × $115,400 principal due after June 1 payment = $8,078 interest per year; $8,078 ÷ 360 days = $22.44 interest per day; 15 days of accrued interest to be paid by the seller × $22.44 = $336.60 interest owed by the seller; $115,400 + $336.60 = $115,736.60 payoff of seller's mortgage • Real estate taxes (estimated at $3,450): $3,450 ÷ 12 months = $287.50 per month; $287.50 ÷ 30 days = $9.58 per day • The earned period, from January 1 to and including June 15 (5 months, 15 days): $287.50 × 5 months = $1,437.50; $9.58 × 15 days = $143.70; $1437.50 + $143.70 = $1,581.20 seller owes buyer • Transfer tax ($0.50 per $500 of consideration, or fraction thereof): $230,000 ÷ $500 = $460; $460 × $0.50 = $230 transfer tax owed by seller • Buyer's tax reserve payment: $2,012.50 paid to separate account (7/12 of the anticipated county real estate taxes of $3,450) • Buyer's one-year hazard insurance payment: $3 per $1,000 of appraised value ($230,000 ÷ 1,000 × 3 = $690 paid in advance to insurance company) • Buyer's first full payment, including July's interest due (15 days × $25.56 = $383.40) on August 1 • The seller's loan payoff is $115,736.60. The seller must pay an additional seller's fee of $25 to record the mortgage release, as well as $100 for a pest inspection and $200 for a survey, as negotiated between the parties. The Uniform Settlement Statement used for most residential closings consists of two to three pages. It is divided into Sellers and Buyers/Borrowers sections, and further subdivided into credits and debits for each party. This document replaced the previous HUD-1 with the intent of making it easier to understand for the public. The HUD-1 may still be used in cash transactions.

Appraisal fees

The purchaser usually pays the appraisal fees. When the buyer obtains a mortgage, it is customary for the lender to require an appraisal, and the buyer bears the cost. If the fee is paid at the time of the loan application, it is reflected on the closing statement as already having been paid.

Survey fees

The purchaser who obtains new mortgage financing customarily pays the survey fees. The sales contract may require the seller to furnish a survey. Most real estate contracts in Illinois require that the seller furnish a current survey to the buyer. As a result, the expense of preparing a survey usually is borne by the seller.

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 normally is 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 distributed as an expense between both parties or according to some other arrangement.

General Rules for Prorating

The rules or customs governing the computation of prorations for the closing of a real estate sale vary greatly from state to state. The following are some general guidelines for preparing the closing statement: • In most states, the seller owns the property on the day of closing, and prorations or apportionments usually are made to and including the day of closing. In a few states, however, it is provided specifically that the buyer owns the property on the closing date. In that case, adjustments are made as of the day preceding the day on which title is closed. • Mortgage interest, general real estate taxes, water taxes, insurance premiums, and similar expenses usually are computed by using 360 days in a year and 30 days in a month. However, the rules in some areas provide for computing prorations on the basis of the actual number of days in the calendar month of closing. The agreement of sale should specify which method will be used. • Accrued or prepaid general real estate taxes usually are prorated at the closing. When the amount of the current real estate tax cannot be determined definitely, the proration is usually based on the last obtainable tax bill. • Special assessments for municipal improvements such as sewers, water mains, or streets usually are paid in annual installments over several years, with annual interest charged on the outstanding balance of future installments. The seller normally pays the current installment, and the buyer assumes all future installments. The special assessment installment generally is not prorated at the closing. A buyer may insist that the seller allow the buyer a credit for the seller's share of the interest to the closing date. The agreement of sale may address the manner in which special assessments will be handled at settlement. • Rents are usually adjusted on the basis of the actual number of days in the month of closing. It is customary for the seller to receive the rents for the day of closing and to pay all expenses for that day. If any rents for the current month are uncollected when the sale is closed, the buyer often agrees by a separate letter to collect the rents if possible and remit the pro rata share to the seller. • Security deposits made by tenants to cover the last month's rent of the lease or to cover the cost of repairing damage caused by the tenant generally are transferred by the seller to the buyer

Closing in Escrow

The seller usually deposits • the deed conveying the property to the buyer; • title evidence (abstract and attorney's opinion of title, 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); • bill of sale; • survey; • transfer tax declarations; • paid water bill; 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 and flood insurance (if required); 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. If the seller dies prior to the closing date, but after having given a signed deed to the escrow agent, the closing still may proceed, with the escrow agent transferring title to the buyer and turning the purchase price over to the seller's estate.

Recording expenses

The seller usually pays for recording charges (filing fees) necessary to clear all defects and furnish the purchaser with a marketable title. Items customarily charged to the seller include the recording of release deeds or satisfaction of mortgages, quitclaim deeds, affidavits, and satisfaction of mechanics' liens. The buyer pays for recording charges that arise from the actual transfer of title. Usually, such items include recording the deed that conveys title to the purchaser and a mortgage or deed of trust executed by the buyer.

Closing costs

The unpaid balance of the seller's mortgage as of June 1st will be $115,500. Payments are $825 per month, with interest at 7 percent per year on the unpaid balance. The seller submits evidence of title in the form of a title insurance binder at a cost of $30. The title insurance policy, to be paid by the buyer at the time of closing, costs an additional $540, which includes $395 for the lender's coverage and $145 for the owner's coverage. The seller must pay $20 for the recording of two instruments to clear defects in the seller's title. The seller must also pay an attorney's fee of $600 for preparing the deed and for legal representation, which will be paid from the closing proceeds. The buyer has agreed to pay for the state transfer tax stamps in the amount of $115 ($0.50 per $500 of the sales price or fraction thereof). The buyer must pay an attorney's fee of $500 for examining the title evidence and for legal representation. The buyer must pay $20 to record the deed and $50 to record the mortgage.

Special information booklet

This HUD booklet, which must be given at the time of application or provided within three days of loan application, 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. The Loan Estimate (LE) of settlement costs makes it easier for borrowers to compare loan conditions and fees from one lender to another, and prohibits lenders from underestimating certain fees in order show borrower lower costs. The only fee that the lender may collect before the applicant receives the LE is for a credit report. Once the LE is issued, lenders are committed and may only modify the LE in certain specific instances. If certain information or circumstances change after the original LE is issued, then a new LE must be issued. As the transaction progresses towards closing, the borrower will be issused a Closing Disclosure (CD), which must be issued at least three business days prior to closinf. Issuing a new CD triggers a new three-day waiting period; in which case, closing may not occur until after three days have passed. The new CD indicates which closing costs may or may not change prior to settlement and, if they do, by how much. The fees are divided into three categories: • No tolerance—fees that may not increase before closing: lender charges for taking, underwriting, and processing the loan application, including points, origination fees, and yield spread premiums • 10 percent tolerance—fees that cannot increase by more than 10 percent in any given category: settlement services for which the lender selects the provider or for which the borrower selects the provider from the lender's list, title services and title insurance if the lender selects the provider, and recording fees • Unlimited tolerance—fees for services that are out of the lender's control: services for which the borrower chooses the provider (such as escrow and title insurance), impounds for taxes, mortgage interest, and the cost of homeowners' insurance

Mortgage servicing disclosure statement

This statement tells the borrower whether the lender intends to service the loan or to transfer it to another lender. It will also provide information about resolving complaints. The last page of the CD is a worksheet consumers can use to compare different loans and terms to aid in price shopping. The lender is responsible for the accuracy of the CD and the actual costs that the lender charges on the Settlement Statement

Controlled Business Arrangements

To streamline the settlement process, 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, a system known as a controlled business arrangement (CBA). RESPA permits a CBA as long as a consumer is clearly informed of the relationship among the service providers, that participation is not required, that other providers are available, and that the only thing of value received by one business entity from others, in addition to permitted payments for services provided, is a return on ownership interest or franchise relationship. Fees must be reasonably related to the value of the services provided and not be fees exchanged among the affiliated companies simply for referring business to one another. This referral-fee prohibition may be a particularly important issue for licensees who offer computerized loan origination (CLO) services to their clients and customers. CLOs that provide services to consumers may charge for the services provided; the fees must be disclosed on the HUD-1 or HUD 1A settlement statement. While a borrower's ability to comparison shop for a loan may be enhanced by a CLO system, the range of choices must not be limited. Consumers must be informed of the availability and costs of other lenders (click here to see a sample affiliated business arrangement disclosure).

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.

Lender's Interest at 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 lien 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. Therefore, lenders may require a survey, a pest control or another inspection report, or a certificate of occupancy (for a newly constructed building). In order to ensure that the buyer takes good and marketable title at closing, lenders generally require a mortgagee's title insurance policy. The buyer must also provide a fire and hazard insurance policy (along with a receipt for the premium). A lender usually requests that a reserve account be established for tax and insurance payments so that these payments are maintained. Lenders sometimes even require representation by their own attorneys at closing.