Chapter 14: Closing the Residential Transaction

To calculate the amount of interest paid per diem, we must use the following formula:

(Loan Amount x Interest Rate) / 360 days. It is important to note here that lenders use a 360-day calendar, rather than a 365-day calendar

RESPA applies to all

"federally related mortgage loans." As with any complex congressional act, a host of exceptions, exclusions, and special circumstances apply. In general, though, RESPA applies to any sale of a one-to-four family residence, which includes a loan by a commercial lender.

It is also important to understand what the IRS considers an

"interest" in real property, to which FIRPTA applies. Essentially, with the exception of creditors' interests, an interest is defined broadly as any interest in land, land improvements, and buildings

At closing, the debits and credits for each party must add up to

$0. If the buyer's total debits exceed his credits, then the buyer must bring money to closing sufficient to pay the debits down to zero. We call this amount the "cash from buyer to close."

In Georgia, the transfer tax is set at

$0.10 per $100 of the taxable sales price. For example, if a property sells for $350,000, the transfer tax will equal $350,000 divided by 100, which equals $3,500, and then multiplied by $0.10, which gives us $350 in transfer taxes.

However, because the filer is not necessarily the seller and because the rules require the filer to keep the seller's certifications for at least four years,

1099-S filers may just file the 1099-S, instead of asking the seller for certification. Because the 1099-S is not a very burdensome form, filing is often easier than not filing.

Credit

A bookkeeping entry on the right side of an account, recording the reduction or elimination of an asset or an expense, or the creation of or addition to a liability or item of equity or revenue.

Chain of Title

A history of conveyances and encumbrances affecting the title from the time the original patent was granted, or as far back as records are available, used to determine how title came to be vested in current owner.

Real Estate Settlement Procedures Act (RESPA)

A federal law requiring the disclosure to borrowers of settlement (closing) procedures and costs by means of a pamphlet and forms prescribed by the United States Department of Housing and Urban Development.

Closing day. People gathered around a table overflowing with piles of papers.

A fidgety buyer perplexed by paperwork. A closing officer, eager to get going on the documents. A seller anxiously awaiting a check. A sales agent or broker, hoping the deal holds together for another hour. If all goes well, by the end of that hour, a happy home buyer will leave with keys, and all the other people in the room will go with checks and documents, all signed and valid

Abstract of Title

A summary or digest of all transfers, conveyances, legal proceedings, and any other facts relied on as evidence of title, showing continuity of ownership, together with any other elements of record which may impair title.

Proration

Adjustments of interest, taxes, and insurance, etc., on a pro rata basis as of the closing or agreed upon date.

Exceptions to FIRPTA Withholding Requirements There are several scenarios involving foreign persons transferring interests in real property to which FIRPTA's withholding requirements do not apply, as follows:

Amount realized is less than $300,000. First, the most common scenario involves an otherwise-covered transfer for which the amount realized in the transaction is less than $300,000. In these smaller transactions, buyers/transferees are not obligated to withhold and remit 15 percent of the amount realized. However, if the seller fails to pay the IRS the taxes owed, the buyer/transferee may still be responsible for the seller's tax liability as well as any related interest and penalties. Exemptions when underlying property is an interest in a domestic corporation. There are also exemptions for the acquisition of real estate owned by a domestic corporation when that corporation's stock is traded on an established securities market, and transfers of interests in domestic corporations when the corporation certifies in writing and under penalty of perjury that the interest is not an interest in U.S. real property. Transferor certifies under penalty of perjury that FIRPTA does not apply. Transferees/purchasers are also exempt from the reporting and withholding requirements when a seller provides a written statement, signed under penalty of perjury, stating that the transferor is not a foreign person. The writing must include the transferor's name, U.S. tax ID number, and home address (or business address, if the transferor is a business entity.) This exemption also applies when the transferor gives such a certification to an independent attorney or title company handling the transaction. IRS provides a Withholding Certificate. If the purchaser/transferee receives a Withholding Certificate from the IRS excusing withholding, then no such withholding is required.

Opinion of Title

An attorney's written evaluation of the condition of the title to a parcel of land after examination of the abstract of title.

Form 1099-S isn't necessary for a gift or a bequest.

And if the transfer satisfies a debt secured by the property, as with a foreclosure or abandonment, then 1099-S isn't required. You also don't have to file if the gross proceeds are less than $600. Or if the transferor is a corporation, a governmental unit, or an exempt volume transferor

Example on how To calculate the amount of interest paid per diem in a closing The closing date is set for August 12th.The buyer is obtaining a new mortgage for $260,000 at a 4.5% interest rate.The seller's existing mortgage has a loan balance of $92,000 at a 5.25% interest rate.

As stated above, the buyer will own partial interest for the remaining days in August, after the closing occurs. So, how much interest does the buyer owe for the month of August? First, we determine the per diem interest payment.This equals $260,000 x 0.045, or $11,700 in annual interest. Then we divide $11,700 by 360 days to get $32.50 in interest paid per diem. Next, we determine how many days of interest the buyer is responsible for.August has 31 days and since the closing is set for August 12th, the buyer will be responsible for 31 days minus 12 days, which equals 19 days of interest. Next, we determine the total amount of interest due in August.For this, we simply multiply the per diem amount by the number of days, which equals $32.50 multiplied by 19 days to get $617.50. The buyer will be debited $617.50 on the settlement statement.

The buyer will not have their first mortgage payment until June 1st. The June 1st payment will include the interest owed for the month of May, but what about the last 13 days in April?

At closing, the buyer will pay the interest for the last 13 days of April, which will be marked as a debit on the settlement statement.

Let's clear up the mystery with a story about a closing Imagine Gertrude wants to sell her house and hires Tom as her agent. They list Gertrude's house for $300,000. If the house sells at that price, Tom's brokerage firm will earn $18,000 in commission. Agent Tom finds Cynthia, who loves Gertrude's house. Gertrude and Cynthia sign a purchase contract spelling out the terms of their deal. However, Cynthia only has $31,000 in cash. She has to borrow some money—actually, a lot of money—to buy Gertrude's house. Who will lend Cynthia the $269,000 she doesn't have?

Borrowmoney Bank will lend Cynthia $269,000. Cynthia's credit is good, and she has a steady income. However, Borrowmoney Bank wants some things in exchange. Borrowmoney wants Cynthia to pay interest on the loan and it wants protection if Cynthia doesn't repay the money. To get this protection, Borrowmoney Bank wants Cynthia to sign a promissory note and a mortgage deed. The mortgage deed will give Borrowmoney a powerful legal right called foreclosure. If Cynthia stops paying her loan payments, the mortgage deed allows Borrowmoney to take possession of Cynthia's house, sell it, and repay the loan from the proceeds. Foreclosure is an awesome power for Borrowmoney Bank to hold over Cynthia, but without Borrowmoney's loan, Cynthia wouldn't have a chance of buying Gertrude's house. She's happy to have that chance, so she's willing to give Borrowmoney that power.

The exact definition of marketable title varies by state and the local definition always controls the meaning.

But the central idea is this: Marketable title exists if the land records show that the seller owns the property and that the seller can convey the property free of any significant claims, encumbrances, or liens by third parties.

At closing, parties to a real estate transaction connect all the loose threads

Buyers sign loan documents. Sellers sign deeds. Buyers receive new house keys. Sellers turn their property into cash. Lenders make it all possible by becoming long-term partners with buyers. Sellers, lawyers, closing agents, title insurers, and real estate agents are paid. Usually, everyone's happy

RESPA requires the lender to provide the buyer with a

CD at least three business days before closing. This three-day period allows the buyer to review the numbers and understand the transaction before closing. To meet the three-day rule, the lender will gather all the required numbers and information well before closing—maybe as many as 10 days before closing.

The Closing Disclosure is relatively new

Congress revised RESPA in 2010, transferring RESPA oversight responsibility to the Consumer Financial Protection Bureau—the CFPB. The CFPB created the Closing Disclosure form and required lenders to use the CD form beginning October 3, 2015.

Finally, the buyer needs to know that the lender has approved her loan and that the money is actually available at the closing

Everyone who needs to be paid—the seller, the lawyers, the title insurer, or the agent—needs to be paid

Example of prorate hazard insurance premiums The closing date is set for October 12th. The seller pays $1,200 per year in hazard insurance, with an end date of January 15th. To determine how much the seller will be reimbursed by the insurance company, we must take the following steps.

First, we calculate the amount of insurance paid per diem. This equals $1,200 divided by 365 days, which gives us $3.2877 per diem. Next, we calculate the number of prorated days beginning with the day after closing and ending with the last day of the policy. There are 19 days remaining in October, November has 30 days, December has 31 days and January will have 15 days until the closing. This gives us a total of 95 days. Finally, we multiply the number of prorated days by the per diem amount. This equals 95 days multiplied by $3.2877, which gives us $312.33. The seller will be credited $312.33 on the settlement statement. In other words, the seller's insurance company will reimburse the seller $312.33 for the days they pre-paid but no longer owned the property.

Example of how to prorate rental income We'll assume the closing date is October 18th and the monthly rental income is $1,500.

First, we determine the amount paid in rent per diem. This equals $1,500 divided by 31 days (since there are 31 days in the month of October), which gives us $48.3871 per diem. Next, we count the number of prorated days for rental income starting the day after closing and until the end of the month. This equals 31 days minus 18 days, which gives us 13 days. Finally, we multiply the rent per diem by the number of prorated days. This equals 13 days multiplied by $48.3871, or $629.03. This means the buyer will receive a credit for $629.03 at closing, while the seller will be debited the same amount.

Example on how To calculate the amount of interest paid per diem We'll assume the loan amount is $370,000 at an interest rate of 4.25%.

First, we must multiply $370,000 by 0.0425 (the interest rate expressed as a decimal) to get $15,725. This is the amount paid in interest on an annual basis. Next, we divide $15,725 by 360 days (remember lenders use a 360-day calendar) to get $43.69 paid in interest each day.

Title insurers usually issue title policies for buyers and lenders.

For buyers, the title insurer defends claims that threaten the buyer's title to the property or impair any of the rights in the buyer's bundle of rights. For lenders, the title insurer defends claims that might affect the lender's mortgage, like the claims of other lenders.

But absences in the land records can affect marketability as well

For example, Wilbur would have a title problem if Jane found that Monty sold to Constance, Constance sold to Heinrich, Phillip sold to Eileen, and Eileen sold to Wilbur. What happened between Heinrich and Phillip? How did Phillip acquire the title Heinrich held? If the record does not explain this jump from Heinrich to Phillip, then Wilbur has a problem with his title. He has a "cloud" on his title.

Mortgage payments are typically paid in arrears (or, in the past).

For example, a mortgage payment made on May 1st will be for the month of April. When it comes time to close on a property, the seller will still owe partial interest on their mortgage for the month in which the closing occurs, since they will not make the next mortgage payment. This will be written as a debit to the seller on the closing settlement statement.

The fourth page discloses some important features of the loan that the dollars-and-cents of the first three pages might not reveal. (CD)

For example, here, the lender discloses whether it will allow someone else to assume the mortgage—to allow someone else to take the borrower's place in the loan

In Georgia, the intangible tax is equal to the new loan amount divided by $500, and then multiplied by $1.50. In other words, $1.50 per every $500 of the loan amount.

For example, if a buyer obtains a $420,000 mortgage to purchase a $525,000 house, how much is paid for the intangible tax?

Example of RESPA

For example, if a lender recommended a certain title insurer, the title insurer might charge a higher rate than they normally would for title insurance, and send a portion of the overcharge back to the lender, in exchange for the referral. As a result, buyers sometimes wound end up paying more for services, from recommended providers, than they would pay someone else for the same service.

It is important to note that if the buyer assumes the seller's existing mortgage, that mortgage amount will be subtracted from the taxable sales price.

For example, if a property sells for $250,000, and the buyer assumes the seller's existing $90,000 mortgage, the transfer tax will be applied to $160,000, rather than $250,000.

The three-day window can delay the transaction

For example, if some numbers on a Closing Disclosure change by a certain amount, then RESPA requires the lender to give the buyer a new CD and a new three-day waiting period to review the new CD.

For this reason, you have to determine the amount paid per month in taxes and insurance by simply dividing by 12 months.

For example, if the annual property taxes amount to $6,500, how much is paid in taxes each month in escrow? To find this, we divide $6,500 by 12 months to get $541.67.

Example of Total Interest Percentage

For example, if the buyer borrows $100,000 and pays $56,000 in interest over the life of the loan, the total interest percentage, or TIP would be 56%. The TIP helps borrowers compare loans using the same metrics.

From the buyer's perspective, they will not make a mortgage payment until after one full month of ownership of the property.

For example, if the buyer closes on March 15th, their first mortgage payment wouldn't be until May 1st. The May 1st mortgage payment will include principal and interest paid for the month of April, since the mortgage payment is paid in arrears. For this reason, the buyer is still responsible for paying interest on the loan for the remaining days in March, after the closing occurs. This partial interest payment will also be marked as a debit towards the buyer on the settlement statement.

Example of Marketable title

For example, many properties are subject to third party interests that do not affect the marketability of title. A power company might have the right to run power lines across a section of property. A neighbor might have the right to draw water from a property well. A neighbor might have the right to cross use a driveway to reach his own property. Interests like these usually do not affect the marketability of title because they don't unreasonably hinder the buyer's use of the property and would not prevent the buyer from selling the property later.

For many of the expenses on the CD, one party will pay the entire expense on their own

For example, the buyer pays for borrowing money for the transaction, and the seller pays off his own mortgage loan.

The factor can be obtained from a chart provided by the lender (or it can be obtained by simply Googling for mortgage factor charts online).

For example, the mortgage factor chart will show that the factor for a 30-year, fully amortized loan at a 4% interest rate is 4.77. Or, the factor for a 15-year fully amortized loan at a 5.25% interest rate is 8.04.

However, we incur some expenses over time, but pay for them intermittently

For example, we pay real estate taxes once or twice a year, but those payments cover liabilities incurred over a year

There are also special rules when corporations are involved

Foreign corporations that dispose of or distribute real property in the United States are subject to a 21 percent tax withholding rate on the amount of gain the company recognizes.

What information does 1099-S ask for?

Form 1099-S is a simple form. It only takes up a third of a page. Basically, the IRS wants to know how much, to whom, for what, and when.

What if you just sell a building, without land?

Form 1099-S stills applies. The Code expressly requires a 1099-S report for the sale or exchange of a residential, commercial, or industrial building. 1099-S reporting also applies to the sale or exchange of condominiums or shares in a cooperative housing corporation. Oh, and to the transfer of any non-contingent interest in standing timber

Congress also intended RESPA to prevent kickbacks and unearned fees.

However, Congress recognized consumers might benefit from efficiencies when a lender refers consumers to settlement service providers the lender owns, or when the lender and the provider are both owned by another entity. RESPA calls these interrelated businesses "affiliated business arrangements."

Buyer's Duty to Inquire and Report As noted above, the responsible party for paying taxes on the sale of real estate is the seller/transferor

However, when the seller is a foreign person, it is the transferee who holds the burden of determining whether FIRPTA applies and, if so, complying with the law.

Example of debits and credits

Imagine Martini buys Potter's house for $200,000 cash. Before closing, Martini has an account called "Cash" with $200,000 and an account called "House" with nothing. At closing, he gives $200,000 to Martini, and Martini gives him the deed to the house. From Martini's perspective, in terms of debits and credits, Martini would record a $200,000 debit in his "Cash" account, but credit his House account with a house. Now consider Potter's perspective. Before closing, Potter had $0 in his cash account and a house in his "House" account. After closing, Potter will debit his "House" account by one house, and he will credit his cash account by $200,000. To Potter, the house is a debit; to Martini, it's a credit. To Martini, the $200,000 is a debit; to Potter, it's a credit.

Example of Prorating

Imagine that in their town, the property tax year runs from September 1 to August 31, and residents prepay property taxes each year on September 1. Suppose on September 1, Potter pays $1,000 in real estate taxes. Let's imagine further that Martini and Potter schedule their closing for March 1—midway through the property tax year. The taxes for the period before closing are Potter's responsibility, but the taxes after closing are Martini's responsibility. However, Potter prepaid 100% of the taxes for the whole year, but he only bears one-half the responsibility. So, on the Closing Disclosure, Potter will receive a pro-rated credit of $500, representing one-half of the $1,000 in taxes he prepaid. Martini will receive a debit for $500, representing reimbursement to Potter for the one-half of the tax expense Potter pre-paid.

Congress wanted to make it easier for consumers to understand and compare loans and to prevent the kickbacks and unearned fees that resulted in higher closing costs

In 1974, Congress enacted RESPA to achieve these goals. Congress has amended RESPA many times, with the latest amendment coming after the 2008 housing crisis in the 2010 Dodd-Frank Act.

As a result, consumers sometimes had difficulty understanding the loans or finding meaningful ways to compare loans offered by different lenders.

In addition, some parties involved in the settlement process—title insurers and title searchers, among others—seemed to have special arrangements between themselves and with the lenders for referring business to one another. These arrangements included kickbacks between the parties

Next, let's discuss how to prorate rental income.

In income producing properties, the rental income collected each month must be prorated between the buyer and seller at closing.Rental income is typically collected in advance for the upcoming month. Rent for a residential property is typically collected once a month, which means the amount prorated is based on the number of days in the month

If the searched title discloses issues more complicated than the seller's mortgage, then the buyer needs assurances, before closing, that the seller has resolved the problems.

In practice, the attorneys hammer these issues out before the parties schedule a final closing date. If there is a broken link in the chain of title, the seller's attorney will have found the missing deed and completed the chain. If there is an outstanding tax liability, then the seller will provide a discharge showing she paid the liability or a check cut at closing will go towards paying the outstanding taxes. When the cloud on the title is more complicated—like a boundary dispute that casts uncertainty on what the seller is selling, then the parties may delay closing to allow the seller's attorney to work out the trouble. The key is that all title issues must be resolved by closing day. This is essential because the most important thing the buyer will receive from the seller on closing day is marketable title—which is the right to claim legal ownership of the property with the authority of the courts to back up the buyer's claim against anyone else in the world.

The courts support the title system

In resolving disputes about ownership of real property, courts presume the record owner identified in the land records is the legal owner of a particular property

Imagine I took a watch off my wrist, held it out to you, and offered to sell it to you for $50. If you were interested in buying the watch, how would you know I owned it? What could I show you to prove I had the right to sell the watch? If I show you a receipt from a store, how would you know that receipt was for the particular watch I was dangling in front of you? How would you know the receipt was even real, if it came from a store you didn't know?

In the case of a watch, you might let the whole ownership question slide. I have the watch. You can take the watch from me right now, in exchange for $50. You can examine the watch closely and judge its quality directly. The watch is portable, and it's inexpensive. Once we part company, you'll get to keep the watch. Given all these circumstances, you might overlook ownership concerns and just take me up on my offer.

We usually have amounts that someone prepaid for the future or accrued expenses that remain unpaid

In these circumstances, we divide the expense, assigning a portion to the seller and a portion to the buyer. We call this process, pro-rating

Remember, the lender must provide the CD at least three business days before closing. Not three calendar days, not three weekdays—three business days

In this context, business days means all days except Sundays and federal holidays. This timing issue can lead to some confusion, so let's take a moment to clarify how it works.

Title Insurance

Insurance to protect a real property owner or lender up to a specified amount against certain types of loss, e.g., defective or unmarketable title.

(Closing Disclosure) The second section, titled "Loan Terms," describes the major terms of the loan.

It shows the loan amount, the interest rate, the monthly payment for interest and principal, and whether the loan includes a prepayment penalty or a balloon payment.

On the other side of the transaction, the seller is also responsible for paying partial interest for the month of August. So, how much does the seller owe?

Just like with the buyer, we first determine the per diem interest payment.This will equal the loan balance of $92,000 multiplied by 0.0525, which gets us $4,830 in annual interest. We then divide $4,830 by 360 days to get $13.42 in per diem interest. Next, we determine how many days of interest the seller is responsible for.The seller is responsible for the first 12 days of August since they still own the property through the closing date. Finally, we determine the total amount of interest due in August by multiplying $13.42 by 12 days to get $161.04. The seller will be debited $161.04 on the settlement statement.

Example of three day period

Let's imagine that Martini is buying a house from Potter, and the Bailey Brothers' Building and Loan is financing Martini's purchase. Suppose Martini, Potter, and Bailey Brothers' schedule the closing for a Thursday in a week without holidays. Counting back three business days from Thursday, we get Wednesday—one day; Tuesday—two days; and Monday—three days. So, by this count, Bailey Brothers has to give Martini the CD by Monday. That's three calendar days and three business days. But things change if they schedule closing for Wednesday. Counting back three business days from Wednesday, we get Tuesday—one day; Monday—two days; Sunday—wait, don't count Sunday because it's not a business day; and Saturday—three days. In this situation, Bailey Brothers' has to give Martini the CD by Saturday. That's three business days, but four calendar days. If you add a holiday into the mix, additional days appear. For example, suppose Martini, Potter and Bailey Brothers' chose the Tuesday after Martin Luther King Day. Counting back three business days goes like this: Monday—holiday; Sunday—not a business day; Saturday—one day; Friday—two days; and Thursday--three days. Here, Bailey Brothers would have to provide the CD five calendar days before closing because two of the intervening days are not business days.

The lender's concerns overlap with the buyer's in many ways

Like the buyer, the lender needs to know that clear title to the property exists and that the seller is conveying the title with a valid deed. In addition, the lender needs to know it has protected its future interest in the property with a binding mortgage deed.

The closing is usually a face-to-face meeting. Where is the meeting, you ask?

Maybe an attorney's office, or the title insurer's office, or the lender's conference room. The place must be large enough to hold all the parties involved in the transaction and it must be near a copy machine, so everyone can receive copies of all the signed documents they need.

At closing, all the parties involved in a real estate transaction finish the deal.

Money and title change hands. A new owner saunters out of the room, now legally recognized as the owner of a plot of land. The old owner "converts" their property into cash.

A similar calculation happens with mortgage interest.

Mortgage interest accrues daily. If you pay a loan off, the interest ends. Each day, the lender waits to see if you will repay the loan before charging interest

To find this, we must first divide the loan amount by $500. Remember, the intangible tax is based on the loan amount, not the purchase price. $420,000 divided by $500 equals $840.

Next, we multiply $840 by $1.50 to get an intangible tax of $1,260.

Closing

Process by which all the parties to a real estate transaction conclude the details of a sale or mortgage. The process includes the signing and transfer of documents and distribution of funds

Debits and credits depend on your point-of-view.

One person's debit is another person's credit, even when we're talking about the same thing

Next, let's discuss prorating annual property taxes.

Property taxes are due on specific dates each year; however, even if taxes are due on November 15th, for example, they count toward the current calendar year (January 1 - December 31).Because of this, there will be times when the property taxes have not yet been paid by the closing date. In this case, the buyer will have to pay the full years' worth of taxes after closing and therefore be reimbursed by the seller for the days leading up to (and including) the closing date. In other words, the buyer will receive a credit from the seller and the seller will be debited their portion of the property taxes.

Next, let's go over how to prorate hazard insurance premiums.

Prorating insurance is different from property taxes in that insurance premiums renew on the date the policy was issued, which is usually the closing date for the existing owner.

The Toolkit also explains how mortgage loans work and helps the buyer understand how to shop for loans and figure out whether a loan will be affordable.

RESPA suggests that the lender give this booklet to the buyer as early as possible. The lender must provide the booklet within three days of receiving the buyer's loan application.

Understand FIRPTA Obligations Foreign persons transferring interests in U.S. real estate and purchasers/transferees should understand their reporting and payment obligations under FIRPTA.

Real estate professionals, mortgage brokers, title agencies, and real estate attorneys can also play key roles in helping ensure FIRPTA requirements are met.

Dispositions of real property for purposes of FIRPTA include the following:

Sales Exchanges Liquidations Redemptions Gifts Transfers

Although three days does not sound like a lot of time, if you include a Sunday or a holiday, then the new waiting period can push closing off by a week

Sellers want to get their money and move on. Buyers want to get their house keys and move in. Real estate agents and brokers want to collect their commissions and sell more houses. Last minute delays in closing are frustrating. For this reason, the parties try to provide accurate numbers to avoid triggering delay.

The buyer also wants to make sure the property's condition hasn't changed for the worse, since she signed the contract

She needs to know that all inspections have been finished, and, if the purchase contract required repairs, that the seller has completed the repairs. The best way to make sure these things happened is to do a final walk-through or inspection, just before the closing.

Example of prorating annual property taxes The closing date is set for April 20th; however, the property taxes are not due until May 15th. The annual property taxes due are $3,200.

Since the property taxes have not been paid by the closing date, the buyer will be responsible for paying the full years' taxes on May 15th. For this reason, the buyer must be reimbursed by the seller for the days between January 1st and the closing date. This is because the seller is still responsible for paying the property taxes while they owned the property. Let's go through the steps to determine the amount credited to the buyer. First, we must calculate the amount of taxes paid per diem.To find this, you must take the annual tax bill and divide it by 365 days.This equals $3,200 divided by 365, or $8.7671 per diem. Next, we calculate the number of days starting with January 1st and ending at the closing date of April 20th.January has 31 days, February has 28 days, March has 31 days, and April has 20 days until the closing date. That's a total of 110 days. Finally, we multiply the number of days between January 1st and the closing date by the per diem amount. This equals 110 days multiplied by $8.7671, or $964.38. Since the taxes will be paid after the closing date, the buyer will receive a credit for $964.38 on the settlement statement. The seller will be debited the same amount.

That doesn't work for real property. Real property is expensive.

So expensive, you'll probably have to borrow money from a lender to buy it. And you can't move real property. If you buy a house, you want to know that no one is going to unlock the door someday, walk in, look at you, and demand, "What are you doing in my house?" Your lender wants to make sure this surprise doesn't happen, too. The lender lends you money because it believes you are buying the property from the owner and that you will own the property after closing. Both lender and buyer want proof that the seller who shows up at closing actually has the legal right to sell the property.

So lets review the story about. a closing

So, let's review the situation: Gertrude wants $300,000 for her house. Cynthia wants Borrowmoney to lend her $269,000 so she can buy Gertrude's house. Borrowmoney Bank wants Cynthia to agree to repay her loan with interest and to give Borrowmoney the right to foreclose if she doesn't pay. At closing, the parties resolve all their nested needs, by signing all the paperwork necessary to finalize these transactions. Cynthia will sign the promissory note and the mortgage deed protecting Borrowmoney's interests in the loan and the property. Borrowmoney will issue the checks giving Cynthia $269,000. After Borrowmoney gives Cynthia the money, Cynthia can cut her own check to Gertrude for $300,000. Finally, Gertrude will sign a deed transferring legal title of the house from Gertrude to Cynthia. And, of course, Gertrude will cut a check for Agent Tom's commission.

THE ROLE OF THE CLOSING AGENT (at closing)

Someone in this group of people will serve as the closing agent. Exactly who this person will be, depends on your state, the lender, and the nature of the transaction. The closing agent might be a representative of the title insurance company, an escrow agent, a representative of the lender, or the buyer's attorney. Sometimes it's a person whose sole reason for being in the room is to act as closing agent. What the closing agent does is more important than who they are. The closing agent makes sure everyone signs the required paperwork and then distributes copies and checks to all the right people. Whoever it is, you can be sure the closing agent is an organized person, of trust, who has experience handling real estate transactions.

So, how do the buyer and lender know whether marketable title exists?

Someone—usually a lawyer, a paralegal, or a title examiner—will search the land records for them to find out whether the seller holds title and whether the records contain any third-party claims against the property. The title searcher will look for any document in the land records that affect title to the property—deeds, liens, easements, mortgages, leases—anything. State law usually requires this title search to cover some specified period—for example, the last 40 years.

Next, we'll learn how to calculate the monthly taxes and insurance. These are the 'T' and 'I' in the acronym PITI.

Taxes and insurance are paid on a yearly basis; however, the lender will require the borrower to continue paying these charges into an escrow account each month.

Debit

That which is due from one person to another.

If you sell your real property, the IRS would like to know about it

That's where Form 1099-S comes in. Form 1099-S tells the IRS how much money a seller receives in a property sale.

THE ROLE OF THE BUYER (at closing)

The buyer brings some crucial elements—the desire to buy a new home and the credit-worthiness to do it. But a buyer doesn't fly blindly into the arms of the seller. There's too much money involved for that. The buyer needs to make sure she's getting what she bargained for—marketable title to the property and reasonable protection against the risk that a stranger to the deal may challenge the title she's receiving. With any luck, the only title issue remaining on closing day will be the seller's mortgage and closing will be easy—at least as far as marketable title goes. The seller uses the money the buyer brings to pay off the seller's loan in full and, once the seller's lender receives payment and discharges the mortgage, the buyer has marketable title. However, a signed discharge for the seller's mortgage may not be on the closing table. Lenders often discharge and record the mortgage a few days after closing, after payment has cleared. This delay is usually not important when a reputable commercial lender is involved. But if a private individual or someone other than a standard lender holds the seller's mortgage, then the buyer may want to see a signed discharge at the closing.

The seller's attorney will prepare this deed for the seller's signature

The buyer's attorney reviews it before closing to make sure that the legal description of the property is adequate and that the deed properly conveys the seller's interest to the buyer. The lender will also see and approve the deed before closing.

The buyer also needs to know that she'll receive a valid deed for the property. Does the deed properly describe the property that she's buying? Will the deed provide clear transfer of title from the seller to the buyer?

The buyer's lawyer will have to review the deed to make sure it's legally sufficient.

Who's in the room? It varies from closing to closing, but here's a list of the possible "players":

The buyer. The buyer's attorney. The seller. The seller's attorney. Representatives of any lenders. A real estate sales agent or broker. A representative of the title insurer. Finally, a closing officer. The buyer's aunt Harriet may also come along for the ride, but for the most part, this is the list. Not everyone I named comes to closing. The most stripped down version of a closing is just the buyer and a closing agent.

The federal government wants to make sure that buyers understand the terms of the loans they are undertaking

The federal government also wants to protect buyers from artificially inflated costs associated with the settlement of the sales transaction. A law called the Real Estate Settlement Procedures Act, or RESPA, is the mechanism that tries to achieve these two goals.

The last page of the Closing Disclosure provides some other important disclosures.

The fifth page states that the lender must give the buyer a copy of any appraisals at least three days before closing. The fifth page also tells the buyer whether the buyer will still have liability in the event of a foreclosure. A table, titled "Loan Calculations," calculates the total amount the buyer will pay if the borrower pays the loan as scheduled. This table also breaks the total number down, showing the amount the borrower borrowed and the total financing cost of the loan. Finally, the Loan Calculations table shows the Annual Percentage Rate actually paid over the life of the loan and the Total Interest Percentage, which is the total interest amount, paid over the life of the loan, expressed as a percentage of the total amount borrowed. These calculations also appear on the Loan Estimate, and the Buyer can easily compare them.

The Internal Revenue Code names specific transactions that require 1099-S reporting.

The first is a land sale. Form 1099-S is required for any transaction involving the sale or exchange of land. This category includes improved land, unimproved land, and even air space above land. If land is on the menu, the IRS wants a peek at the bill.

What's on the Loan Estimate? The lender's best good faith estimate of all the terms and costs associated both with the loan and with the closing.

The first page identifies the basic terms of the loan—the loan amount, the interest rate, the required monthly payment, and any pre-payment penalties or balloon payments the buyer would have to pay. The first page also summarizes the total closing costs and indicates how much cash the buyer will need to close. With these basic terms all in one place, a buyer can easily compare loans. The second page of the Loan Estimate provides the lender's best estimate for the details of the closing costs. These costs listed include all the things we've talked about in previous lessons, and more—loan origination fees, title search fees, attorneys' fees, appraisal costs, title insurance fees, transfer taxes, recording fees, mortgage insurance premiums—you name it. Just in case there's something not listed on the form, the form also includes a line labelled "Other." You get the idea. The lender is supposed to provide the buyer with a good faith estimate of every cost the buyer might incur with the purchase. The last page provides additional information about the loan, such as whether a home appraisal will be required, whether the lender intends to transfer loan servicing to another entity, whether the lender requires homeowner's insurance, and what happens if the buyer is late on a payment. The last page of the Loan Estimate also includes a section called "Comparisons." This section provides comparisons based on the total loan—not just monthly payments. The Comparisons section tells the buyer how much interest they will pay and how much of the principal they will have paid off by the end of the fifth year.

So what's on the Closing Disclosure? Let's take a little tour. We'll start at the 20,000-foot view and look closer as we go. The CD has five pages. Always five pages and always the same five pages. Get to know and love them, and you'll never be confused.

The first page provides a general loan overview for the buyer. The second page details all the closing costs. The third page summarizes the transaction and calculates how much money the buyer must bring at the beginning of closing and how much money the settlement agent must give the seller at the end of closing. The fourth page discloses important information about how the lender will administer the loan. The fifth and final page provides calculations about the loan as a whole, some additional disclosures, and contact information for key players in the transaction, like the lender, the mortgage broker, the real estate brokers, and the settlement agent.

The third page summarizes the transaction for buyer and seller (CD)

The first section, a table called "Calculating Cash to Close," is for the Borrower. This table figures out how much cash the Buyer must bring to closing by adding up all the closing costs and subtracting any money the borrower has already paid. This table also compares the figures in the Loan Estimate to the figures in the CD and briefly explains any differences between the two. The second section, called "Summaries of Transactions" shows the buyer's and the seller's transaction side by side, listing the debits each owes and the credits each is entitled to. The Borrower's column shows the amounts the borrower must pay at closing, like the purchase price of the property, the total closing costs, and any adjustments the buyer must pay the seller. Then it shows any amounts paid by or on behalf of the borrower, like down payments, loans, refunds, or amounts the seller didn't pay but should have. When you subtract the money that has come in, from the money that must go out, you get the cash the buyer needs to bring to closing.

Let's go over how to calculate the monthly loan payment using the loan amount and the factor. (Principal and Interest) We'll assume the loan amount is $575,000 at a 5.5% interest rate. The loan is fully amortizing with a 30-year term.

The first step is to determine the factor. The chart will show us that the factor for a 30-year loan at 5.5% interest rate is 5.68. Next, we divide the loan amount by $1,000. This equals $575. Finally, we multiply $575 by the factor of 5.68. This gives us a total monthly principal and interest payment of $3,266.

Finally, let's put it all together using the following example. A property is being purchased for $400,000. The buyer will obtain a 30-year conventional loan of $360,000 with an interest rate of 4.5%. The lender is assigning a PMI risk factor of 0.62%. The loan factor equals 5.06. The annual property taxes amount to $7,200, while the annual insurance premium is $1,400. Based on this scenario, what is the monthly loan payment?

The first step is to determine the monthly principal and interest. As we discussed earlier, you determine this by taking the loan amount and dividing it by $1,000, and then multiplying by the loan factor.This equals $360,000 divided by $1,000, which is $360. $360 times the loan factor of 5.06 gives us a monthly principal and interest payment of $1,821.60. The second step is to determine the amount paid in taxes each month. This simply equals $7,200 divided by 12 months, or $600. The third step is to determine the amount paid in insurance each month. This equals $1,400 divided by 12 months, or $116.67. The fourth step is to determine the amount paid in PMI each month. As we discussed a moment ago, we first need to multiply the loan amount by the PMI risk factor to get the annual amount paid in PMI. This equals $360,000 times 0.0062, or $2,232. Then, we divide the annual PMI by 12 months to get a monthly PMI payment of $186. The last step is to add up the PITI and the PMI payment to determine the total monthly payment.The P&I equals $1,821.60. The monthly taxes equal $600, the monthly insurance equals $116.67 and the PMI payment is $186. When you combine these four numbers, you get a total monthly loan payment of $2,724.27.

Second Example of how to calculate transfer taxes In the next example, we'll calculate the transfer tax on a transaction that includes an assumed mortgage. The purchase price is set at $470,000 and the buyer will assume the seller's existing $120,000 mortgage.

The first step we must take is to subtract the assumed mortgage from the purchase price. This equals $470,000 minus $120,000, or $350,000. Next, we divide the taxable sales price by $100, which is $350,000 divided by $100, or $3,500. Finally, we multiply $3,500 by $0.10 to get a transfer tax of $350.

we've talked about all the people who are present at the closing table, but they are not the only people who are interested in the closing.

The government also has an interest in making sure the lender's lending procedures are fair and transparent and that the government receives any taxes owed, because of the transaction

PMI is paid on conventional loans with a loan-to-value ratio greater than 80%

The higher the LTV, the greater the risk to the lender, which means they will charge a higher PMI fee.

Notice there are two big steps to this closing

The money must come first. There are some cash transactions in real estate, but they are rare. Usually, a lender is involved, and the buyer must close on the loan agreement with her lender first to get the money she needs to buy the house. Then—and only then—can the buyer and the seller close on their purchase contract

In addition to PITI, some borrowers may be required to pay an additional mortgage insurance fee if they are obtaining an FHA loan, or their loan-to-value ratio is too high

The mortgage insurance may be in the form of private mortgage insurance (also known as PMI) for conventional loans, or a mortgage insurance premium (also known as MIP) for FHA-insured loans.

The seller's concerns are usually the simplest

The seller needs to know that the buyer has enough money to pay for the property and fulfill the purchase contract.

THE ROLE OF THE SELLER ( at closing)

The seller opened the deal by offering her property for sale. What does she need from the closing? Mostly, the seller needs the buyer's money—the proceeds check for the sale of her property. This check represents the netproceeds of the sale, not the gross proceeds. The seller may have a mortgage loan of her own to pay off, or other property-secured liens or loans she may have gathered while owning the property. She likely has attorney's fees to pay as well, and, of course, she has to pay the agent or broker a commission for bringing the buyer to the closing table. So, in addition to collecting a net proceeds check, the seller needs to use the buyer's money to pay everyone who assisted her in the sale as well. But the buyer will not pay the seller until she delivers marketable title to the property in the form of a deed acceptable to the buyer. As we explained in the last lesson, the buyer, the lender, and the title insurer will have examined the seller's title closely, by searching the land records. If the title search revealed any title defects or clouds on the title, then the buyer will have told the seller about these title issues. The seller is responsible for resolving all of those title issues by closing, usually by instructing her attorney to fix any defects discovered during the title search. The seller must also complete any of the other obligations she accepted in the sales contract. Did the house need new carbon monoxide detectors? Was the seller supposed to repair a defective boiler? Did the seller agree to remove an unsightly rubbish pile from the back yard? If so, the seller must do all these tasks by closing day.

Let's go over an example to clarify how this works. We'll assume a property closes on April 17th.

The seller was supposed to pay April's interest as part of the mortgage payment due on May 1st. For that reason, the seller is responsible for paying interest on their mortgage from April 1st to the 17th, or 17 days. The 17 days of interest owed by the seller will be paid at closing and will be marked as a debit to the seller on the settlement statement.

Who is the 1099-S filer?

The short answer is the settlement agent. The person responsible for filing 1099-S is "the person responsible for closing the transaction." In most circumstances, that person will be the settlement agent named in the closing statement. That's the short answer, but the IRS provides some additional rules to identify the responsible person when the short answer doesn't work. I'll go through the rules here. They may seem tangled, but they make more sense if you think of them as starting with the most sophisticated, impartial actors and moving to the least sophisticated or most partial actors.

(Closing Disclosure) The first page has four basic sections

The top section identifies the borrower, the seller, the lender, and the settlement agent. It also shows the closing date and describes the kind of loan the borrower is taking, like, for example, a 30-year conventional loan.

Let's imagine that Wilbur lives in a state that indexes land records by the names of grantors and grantees. Wilbur is selling his house to Olivia, and Olivia asks Jane to search Wilbur's title. Jane begins by searching the index for every record that involves Wilbur. If Wilbur has a mortgage, Jane makes a note of the mortgage. If the town recorded a tax delinquency notice because Wilbert didn't pay his property taxes, Jane makes a note of the delinquency. She does this for every record involving Wilbur. These items will affect the marketability of Wilbur's title, and Wilbur will have to resolve them at, or before closing.

Then, Jane starts looking at the prior owners. By looking at the deed that gave Wilbur title, Jane learns that Wilbur bought the property from Eileen. Jane then searches the records for everything involving Eileen. Jane learns that Eileen bought the property from Heinrich, and Jane searchers the records for Heinrich, and so on and so on, until Jane has gone back through the records for the required period, looking for any title impairments and noting each person who sold and bought the property. As she works, Jane learns that Monty sold the property to Constance, Constance sold to Heinrich, Heinrich sold to Eileen, and Eileen sold to Wilbur. We call this trail of records, linking buyer to buyer to buyer, the chain of title. If the chain of title is unbroken—if each seller properly conveys title to the next buyer—and the records show no evidence that a third party holds a significant unresolved claim on the property, then we consider the title marketable.

What transactions does Form 1099-S apply to?

Think a big, broad net with a very fine mesh. If a transfer involves the sale or exchange of an interest in real property, the IRS wants a form 1099-S.

We often say that a property owner holds a "bundle of rights" to the property

This bundle includes rights such as the right to possess the property, to use the property, to lease the property to another person, and to sell the property. Title refers to ownership of this bundle of rights.

Next, we'll cover how to calculate the intangible tax on a transaction

This is the second tax that may be included on the settlement statement. An intangible tax is assessed on new loans used to purchase a property. This tax is typically paid by the buyer; however, like the transfer tax, this is negotiable between the parties.

Does this sound a little familiar? Well, maybe it's because these sections mirror the first page of the Loan Estimate, which we discussed a few lessons back.

This mirroring happens by design, not chance.

After a title search, the title examiner provides a report on title to the buyer

This report might be an abstract of title, which is a summary of everything the examiner found in the land records affecting title—all the transfers, conveyances, legal proceedings, and other facts showing continuity of ownership and documenting any facts that might impair title

For that particular service, a buyer can purchase title insurance.

Title insurance protects against the risk of title defects not evident from the land records

Marketable Title

Title which a reasonable purchaser, informed as to the facts and their legal importance and acting with reasonable care, would be willing and ought to accept.

Because each land record office maintains records for properties located within a particular geographic boundary—a town, a county, a region—

the land records affecting title to a particular property are located mostly in a single office.

Let's go over one more example, this time assuming the taxes were paid prior to the closing date. The closing date is set for August 5th. The property taxes were paid on January 15th in the amount of $5,600. Since the property taxes have already been paid by the seller at the time of closing, the seller must be reimbursed by the buyer from the day after the closing date to the end of the year.

To determine how much the seller will be reimbursed, we must first calculate the amount of taxes paid per diem. This equals $5,600 divided by 365 days, or $15.3425 per diem. Next, we calculate the number of days from the closing date until the end of the year.August will have 26 days, September will have 30 days, October will have 31 days, November will have 30 days and December will have 31 days. This gives us a total of 148 days. Finally, we multiply the number of days between the closing date and the end of the year by the per diem amount. This equals 148 days multiplied by $15.3425, or $2,270.69. The buyer will have to reimburse the seller in the amount of $2,270.69 for the days after closing, since they will be the owner of the property.The buyer will be debited $2,270.69 on the settlement statement, while the seller will receive a credit for the same amount.

Example of how to calculate transfer taxes First, we'll assume the purchase price is $280,000 and the buyer is not assuming the seller's existing mortgage.

To determine the amount paid in transfer taxes, we must use the following two steps. First, we divide the purchase price by $100. This equals $280,000 divided by $100, or $2,800. Second, we multiply $2,800 by $0.10. This gives us a transfer tax amount of $280.

The up-front premium is calculated as 1.75% of the loan amount, and the monthly assessment is currently 0.85% of the loan amount, as per FHA guidelines. For example, if a buyer obtains a $245,000 FHA-insured loan, how much is paid in monthly MIP if the up-front fee is rolled into the loan amount?

To determine this, we must first calculate the loan amount with the up-front assessment added in. This equals $245,000 multiplied by 0.0175, which gives us $4,287.50. Then, we add $245,000 to get a new loan balance of $249,287.50. Next, we calculate the annual MIP by multiplying $249,287.50 by 0.0085, which equals $2,118.94. Lastly, we divide $2,118.94 by 12 months to get a monthly MIP fee of $176.58.

For example, if a buyer is purchasing a $620,000 house using a $570,400 loan, how much is paid each month in PMI if the lender applies a 0.68% PMI fee? (Taxes and Insurance)

To find this, we first multiply the loan amount by the PMI fee. This will give us the amount paid per year for the PMI fee. This equals $570,400 multiplied by 0.0068, which gives us an annual PMI fee of $3,878.72. Next, we divide $3,878.72 by 12 months to get a monthly PMI fee of $323.23. Unlike PMI, MIP requires an upfront fee, which may be rolled into the loan amount, plus a monthly insurance premium.

Finally, the Comparisons include a number called

Total Interest Percentage, or TIP, which expresses the total amount of interest the buyer will pay over the life of the loan as a percentage of the amount borrowed

There are six categories under which a seller/transferor may request a certificate from the IRS, including:

Transferor believes the transfer is exempt from tax or is entitled to nonrecognition treatment; The transferor applies based on a calculation of their maximum tax liability; Special installment sale rules apply; There is an agreement for the payment of tax with conforming security; Transferor requests a blanket Withholding Certificate; or The application is based on any other basis. IRS Publication 515 provides more information about each of these categories, as well as detailed instructions on how someone can apply for a certificate.

So, what types of transactions are subject to FIRPTA?

Under the terms of the Internal Revenue Code, FIRPTA's application extends beyond the sale of real estate, including any "disposition" of real property by foreign persons. FIRPTA generally applies even if there is a tax treaty between the U.S. and the foreign person's home country.

THE ROLE OF THE LENDER (at. closing)

Usually, without the lender, the buyer would not be able to purchase the property. So the lender usually comes to closing and brings a very large stack of paper. One of the most informative and most-referred-to pieces of paper, that the lender brings, is the closing disclosure, also known as a settlement statement.The lender's primary purpose at closing is to make sure the lender protects its security interest in the property The lender will also have a pile of other papers like assorted disclosures, a notice of assignment, an affidavit of alternate names, an agreement to correct clerical errors, and all sorts of other goodies. The buyer will sign each paper in turn after someone briefly explains its significance. When the signing is done, the closing agent hands out all the checks, everyone stands up, shakes hands, and goes their separate ways, satisfied with the fruits of the transaction.

Where did RESPA come from?

Well, back in the early 1970's, after lobbying by consumer groups, Congress grew concerned about certain lending practices in the real estate industry. At the time, lenders described their loans to consumers in many ways and included fees and other charges beyond the stated interest rate.

THE ROLE OF THE REAL ESTATE BROKER AND SALESPERSON ( at closing)

Why is the real estate salesperson or broker in the room? Well, you've been with the deal all along, and you were serving as agent to earn your commission. The closing agent cuts that commission check at closing, and the real estate agent or broker is at the closing to collect it. But your closing role extends beyond collecting a check. Chances are, you know the details of this transaction better than anyone else in the room. You've talked the seller and the buyer through the negotiations. You know what their concerns were and how they resolved them. You are the memory of the deal, and if a question comes up at the closing table about some practical point of the sale, you may know the answer when the lawyers, bankers, and insurers do not. You may also have a better understanding of the buyer and seller as people. With your knowledge of the deal and the people involved, you can smooth over rough spots that may arise. You are also the person who is free to step out of the room and grab something—a document, a file—if the parties need it and they don't have it. You help the deal close smoothly.

While the rate of withholding is generally 15 percent,

foreign sellers may ask the IRS to lower the amount of withholding to the amount of tax actually owed, if that amount is less than 15 percent.

Next, we'll cover how to calculate the total monthly loan payment.

You can use the acronym PITI (Principal, Interest, Taxes, and Insurance) to remember the components of a monthly loan payment.

Because the first page of the Loan Estimate and the Closing Disclosure are virtually the same,

a buyer can quickly compare the Loan Estimate the lender gave them when they applied for the loan with the Closing Disclosure the lender provides three business days before closing, and see whether any of the numbers have changed. If these numbers have changed significantly, then the buyer can find out why.

Because the legal system strongly favors the rights of those with recorded interests,

a buyer wants to make sure that the land records identify the seller as the owner before the closing occurs. Specifically, the buyer wants to know the seller can convey "marketable title."

An "account" is any

activity or asset you want to keep track of, like your hand-made jewelry business on Etsy, your personal stamp collection, or your checking account.

Hazard insurance is always paid in

advance and will be marked as a credit to the seller at closing.

Marketable title does not mean that a property is free of

all claims, encumbrances, or liens

Withholding is also not required if the

amount realized is zero, or if the transferee/purchaser is the U.S. government, a U.S. state, possession, or district, or a political subdivision of the U.S.

The Comparisons section also provides the

annual percentage rate, or APR. The APR recalculates the interest rate of the loan, including all the fees associated with the loan, such as loan origination fees or points paid for a discount. A loan with a low interest rate might include high fees that result in the buyer paying more over the life of the loan. The APR allows the buyer to compare loan rates with all the costs included.

When a U.S. citizen sells real estate

any resulting tax obligation is handled through the regular, annual income tax filing process

A cloud on title is

anything that casts doubt about a seller's title

Warranty deeds, quitclaim deeds, mortgage deeds, liens, tax delinquencies, zoning permits, land use permits—

anything that might affect the bundle of rights that make up the title to a piece of real property can be recorded in the land records.

RESPA's beating heart, from the perspective of the buyer,

are the disclosure requirements

Next, we'll cover how to calculate transfer taxes

as this is another settlement statement line item that must be completed. The transfer tax is also known as a conveyance tax. It is commonly paid by the purchaser; however, this may be negotiated between the parties.

RESPA allows lenders to refer consumers to affiliated settlement service providers,

but only if the lender gives the buyer a disclosure called an Affiliated Business Arrangement Disclosure.

Similarly, interest accrues on a mortgage loan daily,

but we only pay the mortgage monthly

When the rental property is sold, the seller gets to keep the portion of the rent through the closing date,

but will credit the buyer for that portion of the monthly rent beyond the closing date.

For the seller, credits will include the

buyer's purchase payment, and debits will include things like loan payoffs and outstanding taxes.

This is where the ideas of title and marketable title come in. We designed our title system to make sure that everyone involved—

buyers, lenders, and the world at large—can easily identify the owner of a property and identify anyone other than the owner who holds a significant interest in the property.

As I said earlier, the presence of a live claim in the record, like an undischarged mortgage or a tax lien,

can make a title unmarketable

Finally, 1099-S asks for the

closing date and the identity, contact info, and federal tax id number of the filer.

The "Other Costs" section includes

costs not related to the loan, like taxes, prepaid expenses, and initial escrow deposits, home inspection fees, commissions to real estate agents or brokers, owner's title insurance fees, or homeowner's association fees. In the "other costs" section, the expenses fall across all three columns. The seller's column gets some expenses (most notably commissions), and the buyer's column gets others. Every now and then, there's an expense paid by someone other than the buyer or seller, which is listed in the "Paid by Others" column.

The most common pro-rated items are things like

county taxes, city taxes, water charges, homeowners' association fees, and condo fees. In general, if you see a recurring expense requiring intermittent payment, a pro-ration may be required.

In general, we call amounts that flow into an account

credits

amounts flowing out of an account

debits

A landowner can sell the

development rights for his property and place the property into conservation

For the buyer, credits will include things like

down payments and loaned funds, and the debits will include things like loan costs, appraisal fees, and title search fees

Withholding Obligations Anyone purchasing or otherwise acquiring real estate from a foreign person is generally considered the withholding agent,

equired to withhold a percentage of the amount realized in the transaction. The onus of determining whether FIRPTA applies and of withholding the appropriate amount of taxes actually rests with the purchaser/transferee.

Anyone who wants to overcome that presumption must present strong

evidence explaining why the presumption should be set aside

With the lease, the owner

expects the conveyance will be temporary; with the conservation, the owner hopes it will be permanent In both instances, the owner keeps all the other rights in the bundle, even though the owner has given away one right

For our purposes, it is enough to think of debits as

expenses that cause money to flow out of an account and credits as money flowing into an account.

(Closing Disclosure)The third section, titled Projected Payments,

forecasts the monthly payments the buyer will need to make each month for principal and interest, mortgage insurance, and escrow funds. This section also estimates the monthly cost of taxes, insurance, and assessments.

The Loan Costs section of the CD details all the costs associated with

getting and creating the loan, like origination fees, appraisal fees, or title search fees. Because the buyer is usually the borrower, the expenses in the Loan Costs section are usually debits for the buyer. The seller's column usually looks empty in the Loan Costs section.

The big item on 1099-S is the

gross proceeds of the transaction. Ultimately, the IRS wants to know how much the seller received in the transaction

If the loan payments will be too low to pay all the interest due in a given month, and the lender will add the unpaid interest to the amount owed, causing the loan amount to grow each month

he lender must tell the buyer here. The fourth page also reminds the buyer that the home is securing the loan and lists the amounts the lender will require the buyer to place in escrow each month.

Let's go over that acronym one more time, because we'll be using it a lot in this lesson, and you'll hear it a lot out in the wild. It pays to know what the acronym stands for.

he title says it all: the Real Estate Settlement Procedures Act—it's a law used in real estate-RE—to regulate settlement procedures—SP—and it's an Act of Congress—A. RESPA!

Title examiners don't just thumb through the land records,

hoping to stumble across something relevant to the property. The records clerk indexes all the land records, either by the names of the people granting and receiving property interests or by the property itself. This indexing is the key to the title examiner's search.

the closing disclosure outlines all the

important numbers of the transaction highlighting where all the money is going, who is being paid, what numbers should be on the checks, and every cent of the transaction coming and going. Federal law requires the lender to provide the closing disclosure at least three days before closing to allow the buyer—and the other parties—a chance to check all the numbers.

Title insurance, like most insurance, protects buyers and lenders against risk—

in this case, the risk that a stranger will appear after the sale, claiming an interest in the property

That single number—the gross proceeds from the sale—

is really the most important item on the form, followed closely by the seller's identity, contact information, federal tax id number, and whether the seller is a foreign person.

The biggest exclusion of all, though,

is the sale or exchange of a residence for $250,000 for single filers or $500,000 for joint filers. Form 1099-S is not required for those sales, provided the seller certifies that the seller used property as a residence for at least two years out of the last five. As exclusions go, this is huge. A large chunk of home sales falls right out of the rule.

The attorney's title opinion is not a guaranty of title—

it is just the attorney's judgment about whether marketable title exists, based on the evidence in the land records. An attorney giving a title opinion does not act as a guarantor or insurer of title.

Although our title system may seem complicated

it works quite well because it is self-correcting.

Although the closing disclosure may be extremely useful from the buyer and seller's points of view,

it's not the most important piece of paper for the lender

The CD is not only useful

it's the law. RESPA—the Real Estate Settlement Procedures Act—requires the lender to give the buyer a Closing Disclosure at least three business days before closing. Like the Loan Estimate, every Closing Disclosure you see will look the same—only the names and numbers will change

This three-page form is highly structured, and every Loan Estimate has the same sections,

laid out in the same order, providing the same kind of information. The only things that change are the names of the parties and the numbers associated with the loan and the sale. This uniformity of appearance makes it easy for a consumer to compare loans and settlement services. The buyer can compare apples to apples and oranges to oranges.

The Closing Disclosure—sometimes called the CD

lays out all the finances of the sale. The Closing Disclosure identifies every expense in the deal and shows who paid what. Because the CD describes the entire deal, it may be the most useful document on the closing table. Parties review the Closing Disclosure for details, long after they stop looking at the deed or mortgage

(Affiliated Business Arrangement Disclosure).In this disclosure, the lender explains how the

lender is related to the settlement services provider, explains that using the affiliated provider will benefit the lender, explains all the fees the affiliated provider will charge, and—crucially—explains that the buyer does not need to use the provider. The lender cannot require the buyer to use its affiliated settlement service providers. The buyer needs to know they can shop around and use someone else. The lender is permitted to require the buyer to use a specified attorney, credit reporting agency, or appraiser in order to protect the lender's interest, but if the lender is requiring a particular attorney, credit agency, or appraiser, the lender must say so on the affiliated business arrangement disclosure form.

Before October 3, 2015,

lenders used a form called the HUD-1 Settlement Statement. The "HUD," as it is often called, lays out the financial details of the loan and sale, just like the CD does

Form 1099-S also asks whether the seller received something other than cash

like property or services, as consideration for part of the deal, because that additional consideration may affect the taxes the seller owes.

In the United States, we keep all the records of conveyances involving real property in

local land record offices. The local officials who maintain these records go by different names—town clerks, county recorders, county clerks—but they all serve the same function.

For now, it's enough to know that closing is that

magical place and time when the parties address and resolve all their unresolved interests and concerns Usually, they do this first by closing the loan and then by closing the sale

Sellers Rights to Obtain Certificates Exempting Mandatory Withholding Sellers who believe they are entitled to pay less than the required 10% or 15% (depending on the transaction amount realized)

may ask the IRS to issue a Withholding Certificate. The IRS has 90 days from receipt of a completed application to review and make a determination. If the certificate is approved, the transferor must notify the transferee of its approval in writing on the day of the transfer or the day prior to it. c

An interest in real property for FIRPTA also includes property such as

mines, wells, and other natural deposits in the United States or the U.S. Virgin Islands. The interest on which taxes are calculated also includes some types of personal property used on the underlying real estate.

The Closing Disclosure is all about money

money coming in and out of the transaction

On the seller's side, you start with the

money the seller is entitled to get, like the purchase price of the property and pro-rated payments from the buyer for amounts the seller prepaid. Then, the column lists the items the seller must pay, like commissions and loan payoffs. When you subtract the expenses due from the seller from the amounts due to the seller, you get the net amount the seller must receive at closing. Taken all in all, the second and third page of the Closing Disclosure lays out the entire transaction for buyer and seller in exquisite detail.

One common claim that would render title unmarketable is a

mortgage. If the seller owes money to a lender, and the lender holds a mortgage deed on the property, most buyers will not accept title unless the seller pays off the loan at closing and the lender discharges the mortgage

The final role for the buyer at closing is to sign the

mountain of forms provided by the lender.

Closing rarely happens on a day when these time-based expenses will resolve

neatly

The seller must be reimbursed by the

nsurance company for the days after closing and until their policy renewal date.

The seller gives the buyer the right to claim

ownership against everyone else in the world by executing a deed—usually a warranty deed—that conveys the seller's interest in the property to the buyer

Even if the title examiner searches the land records well and the attorney's title opinion is sound,

potential claims not clear from the record may still exist.

Any item that involves a recurring payment or accrual will usually receive a

pro-rated treatment.

They record and document transactions that affect title to

real property located in their area, be it town, county, or district.

Transferees (or their closing agents) must then

remit the withheld taxes to the Internal Revenue Service (IRS) within 20 days from the closing. Transferees/purchasers who fail to withhold taxes under FIRPTA may be held personally liable to pay the taxes owed.

RESPA works by

requiring lenders and/or mortgage brokers to give buyers a series of strictly timed disclosures about the loan and by imposing an enforcement scheme to prevent kickbacks and unearned fees. The enforcement scheme includes direct oversight by the Consumer Financial Protection Bureau (CFPB) and indirect oversight through private law suits brought by individuals.

An owner can rent the

right to use the property by leasing it to a tenant

A property owner can separate the

rights in the bundle

The interests or claims we care about are claims that would prevent the buyer from

selling the property later, or claims that do threaten the buyer's use of the land that no reasonable buyer would accept the title with that claim hanging over it

Every buyer knows her property purchase will only be as secure as her title,

so the buyer and her lender check title carefully before closing.

Some say that every clause in a closing document represents a deal that went bad,

somewhere, sometime. No matter how long the note and mortgage are, someone will go over them with the buyer at closing, explaining generally what the documents say. However, when you set the details aside, the terms boil down to the same idea for the buyer—if you pay, you stay; if you don't, you go.

The amount realized includes the principal amount of cash paid or to be paid for a sale and the fair market value of certain other property included in the transaction,

such as farm equipment. If the transferee is assuming any liability with the transaction, that amount is also factored in when calculating the amount realized.

(Closing Disclosure)

summarizes the total closing costs and the cash the buyer will need to bring to closing in order to close. This number is important, because if the buyer does not bring that amount to closing, then the closing cannot happen.

Because the accounting varies depending on who you are

the Closing Disclosure tracks the parties' debits and credits separately, in separate columns

When a non-U.S. resident alien disposes of real estate located in the U.S.,

the Foreign Investments in Real Property Tax Act of 1980 (FIRPTA) applies

While it is the selling taxpayer who owns the tax obligation,

the IRS puts the burden of withholding and paying taxes on the individual or company acquiring the real estate

Here on the second page of the CD,

the buyer can see all the costs required to close the loan itemized in one place, with a nice total at the bottom of each column showing the total closing costs for both buyer and seller. If the borrower wonders how the closing costs got so high, the buyer can look at this page for a detailed explanation. The "closing costs" amount at the bottom of the first page should equal the "total closing costs" shown at the bottom of the second page.

Because the LE (short for loan estimate) includes a good faith estimate of both the loan terms and the closing costs,

the buyer is able to compare all the costs of the loans presented by various lenders and select the lender and the closing that is likely to cost them the least.

Because there is always a risk that the land records do not reveal all the claims that may exist with respect to a property,

the buyer—and certainly the lender—will probably want a title insurance policy, which will provide money to defend the buyer's title if a stranger appears after closing, claiming an interest in the property. The buyer (and lender) will be looking to see that the title insurance is on the table.

After a buyer submits a loan application,

the lender has three days to give the buyer two items. The first item is an informational booklet called "Your home loan toolkit: A step-by-step guide." The toolkit explains the costs associated with closing the loan. It explains things like title insurance, appraisals, and closing agents. The second item the lender must give the buyer is a completed form called a Loan Estimate, or LE.

If the lender can demand early repayment of the loan,

the lender must disclose that here as well

If the buyer defaults on his loan,

the lender wants to be sure the land records properly disclose and record the lender's foreclosure right and mortgage deed. So the lender brings a promissory note—by which the buyer promises to repay the loan—and a mortgage deed (which the buyer signs) —acknowledging the lender's security interest in the property and the lender's right to foreclose.

Every time a sale occurs,

the new buyer reexamines the title and a new title examiner searches the record

Because everyone will have agreed on the wording and deed form,

the only thing left to complete will be the seller's signature. If the seller chooses not to attend the closing, the seller's attorney or the closing agent will bring the signed deed with them to closing. This deed is one of the most important pieces of paper at the closing table because it allows the buyer to hold title against the seller (because the seller has signed away his interest) and against the rest of the world generally. This brings us to title insurance...

For example, if a homeowner purchased their insurance policy on February 15th,

the policy will end the following year on February 14th.

If a cloud on the title exists,

the seller must clear up the issue before the sale can close. In Wilbur's case, he must find the missing link connecting Heinrich and Phillip. Maybe Phillip forgot to record the deed from Heinrich to Phillip. To close, Wilbur (or his attorney) will have to find the missing deed, record it in the land records, and create an unbroken chain of title.

Because the seller's primary duty under a purchase contract is to convey marketable title,

the seller usually moves quickly to fix any defect found.

On the other side, if the property taxes for the year were already paid prior to closing,

the seller will be credited the amount paid in property taxes through the closing date, while the buyer will be debited the same amount.

The promissory note and mortgage deed are long and they can easily run into

the tens of pages because they include a multitude of terms and obligations expressed in form language, developed by the lender over thousands of transactions

If someone appears after closing claiming they have an interest in the buyer's property,

the title insurer will pay the costs of defending the title, up to the amount of coverage, stated in the title insurance policy.

Title insurance provides buyer and lender peace of mind that if such a claim appears,

the title insurer will pay to defend the title

In addition, when the amount of the sale or transfer transaction was more than $300,000 but less than $1 million, and the transferee states in a sworn affidavit that the property will be used as his or her primary residence,

the transferee is only required to withhold and remit ten percent of the amount realized, rather than 15 percent.

When acquiring real estate, whether through a purchase, transfer, gift, or otherwise

the transferee must find out whether the seller/transferor is a foreign person subject to FIRPTA. If the seller is a non-U.S. resident alien, the purchaser/transferee is required to obtain the seller's name, address, and taxpayer ID number and to remit the withheld funds to the IRS to satisfy FIRPTA.

First comes the closing on the loan;

then comes the closing on the property. The entire transaction will only complete when the buyer has the money to fulfill the purchase contract.

If there is no closing statement,

then responsibility falls to the buyer's attorney, if the attorney comes to the closing. If the buyer's attorney doesn't come, then the seller's attorney is responsible, if present.

If the closing statement doesn't name the settlement agent,

then the Code provides an ordered list of people who are responsible. First choice is the person who completed the closing statement, whether it be a HUD-1, a Closing Disclosure, or an informal closing statement. Whoever put the deal numbers together becomes responsible for filing the 1099-S. This makes sense. The person who pulled the numbers together probably knows the details of the transaction.

If that list of rules doesn't produce a responsible filer,

then the Code provides another short list of responsible filers. Listen up, because you might be on it. First up is the mortgage lender. If there is no mortgage lender, then the seller's broker is the responsible party. If there is no seller's broker, then the buyer's broker is the responsible party. No lender and no broker? Well, then it's up to the buyer to file 1099-S.

If the seller can't cure the defect,

then the buyer will walk away from the deal

If no attorneys come to closing,

then the entity that distributes the money becomes the responsible person, whether it be a disbursing title company, an escrow company, or the seller's great uncle Ned. This makes sense because the money-handler is likely to know how much the seller received in gross proceeds.

If the buyer takes title subject to the mortgage, and the seller does not pay off the loan,

then the lender could foreclose on the property and sell the house from under the buyer. Before the sale closes, the buyer is going to want the seller to prove that he paid the loan and that the lender will discharge the mortgage. The buyer's lender is also going to insist on proof that marketable title exists.

Similarly, if the seller's credit exceeds his debits,

then the settlement agent must cut a check to the seller for the excess credits. We call this amount the "cash to seller." These two items—the cash from buyer and the cash to seller—are usually the items we need to adjust to make the debits and credits for the respective parties add up to zero.

If they find a title defect,

they insist that the seller fix the defect before closing

The second page of the CD details the closing costs

this page has two major sections, labeled "Loan Costs" and "Other Costs." The page also has three columns running down its length, labeled Borrower-Paid, Seller-Paid, and Paid by Others. In these columns, the settlement agent will list all the assorted debits to buyer, seller, and others. The Closing Costs page is similar to the second page of the Loan Estimate, but the Loan Estimate only shows the costs to the borrower. The CD shows the costs for both buyer and seller.

With so many motivated eyes looking at the title record,

title defects do not last in the record for long. With a bit of luck, and a lot of title searching, a marketable title will always and ever shine down, clear and unclouded, on the closing table.

The closing affects the interests of many other people as well—

title insurers, lawyers, closing agents, government regulators, and real estate agents, to name a few

Most of these concerns are resolved through documents like

title reports, settlement statements, warranty deeds, mortgage deeds, and checks

Congress intended these disclosure requirements—the buyer's toolkit and the loan estimate—

to provide the buyer with the understanding and information they need to shop around for loans and lenders

Federal law still requires the HUD for

transactions like equity lines of credit or reverse mortgages, but most residential sales now require the Loan Estimate and Closing Disclosure

Purchasers/transferees,

usually through the closing agents for their transactions, are generally required to withhold 15 percent of the sales price.

A person who wants to know who owns a particular property can find out who by

visiting a single land records office. Now, we keep some records that affect title elsewhere. For example, we sometimes store state regulatory permits in a state agency's office. Even in that case, someone usually records a brief notice in the land records stating that relevant records exist somewhere else. This system of one-stop shopping helps keep title to real property easily discoverable.

With so many potential rights-holders in real property,

we need a way to identify owners and find out whether a property owner has conveyed any of the rights in his bundle to anyone else. Our title system is the way we keep track of these property interests

An attorney might also issue an opinion of title,

which provides a legal opinion on whether title is marketable, based on all the records described in a title abstract

RESPA's other big disclosure requirement is the Closing Disclosure,

which the lender must give the buyer at least three days before closing

Foreign persons subject to the law must pay regular taxes to the IRS,

with the amount of taxes due based on the amount of recognized gain

However, most mortgages require payment on the first of each month,

with the first payment due one full month after closing. So, if you close on March 18, your first mortgage payment is usually due May 1. But if a closing occurs on March 18, how does the borrower pay the lender for the interest from March 18 to March 31? Trying to include this partial interest in the loan repayment amortization complicates the math, so the buyer generally prepays the interest that will accrue over the end of the closing month at closing as a closing cost. We pro-rate this interest because the interest only accrues over part of the month.

Because the CD performs the same task as the HUD,

you may still hear people mention the "HUD" or the "Settlement Statement." Don't be confused. Chances are they're talking about the Closing Disclosure

In order to determine the principal and interest on a fully amortized loan,

you must have two numbers; the loan principal (the amount borrowed) and the factor (the dollar amount charged by lenders, depending on the interest rate, for each $1,000 borrowed).

At any closing—not just Cynthia and Gertrude's—

—the buyer and seller have different concerns. The buyer wants to make sure that the seller can convey clear title to the property. Does the seller have a mortgage of her own which the seller needs to discharge? Has a contractor placed a lien on the property for a home repair which the seller hasn't paid for? If so, the buyer needs to know that the seller has cleared up these clouds on the title.