Principles of California Real Estate
Lesson 12:
Closing Real Estate
Transactions
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Closing
Closing: Final stage in real estate
transaction. Also called settlement.
 Buyer pays seller purchase price.
 Seller transfers title to buyer.
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Escrow
In California, closing process is usually
handled through escrow.
Escrow: Arrangement in which neutral third
party holds money and documents for buyer
and seller until transaction closes.
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Escrow
Escrow agent
Escrow agent: Neutral third party selected to
handle closing; also called closing agent.
 Chosen by agreement between buyer
and seller.
 Often appointed in purchase agreement.
 Acts as dual agent, representing buyer
and seller, until transaction is over.
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Escrow
Escrow instructions
The parties usually give escrow agent written
instructions for closing which:
 direct escrow agent to take necessary
steps to close transaction
 specify conditions that must be met
before escrow agent releases funds or
documents
 reflect contingencies and other
requirements in purchase agreement
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Escrow
Escrow instructions
If there is any conflict between escrow
instructions and purchase agreement,
later contract (the escrow instructions)
prevails.
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Escrow
Escrow services
Escrow agent may provide many services,
such as:
 ordering title report and inspections
 preparing documents
 paying off seller’s loan and other liens
 prorating and allocating expenses
 depositing and disbursing funds
 preparing Uniform Settlement Statements
 delivering and recording documents
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Escrow
Purpose and benefits
Escrow’s main purpose is to ensure that:
 seller receives purchase price
 buyer receives clear title
 lender’s security interest is perfected
Escrow’s main benefits are:
 convenience: neither party is required to
attend closing in person
 protection: each party is protected from
change of heart by other party
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Escrow
Purpose and benefits
Deposit into escrow is essentially irrevocable;
once party has placed sum of money or
document into escrow, she can’t get it back
except:
 according to conditions set forth in
escrow instructions, or
 with other party’s consent.
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Escrow
Role of broker
Real estate broker isn’t principal in escrow
transaction and can’t direct escrow agent
during closing process.
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Escrow
Agent’s scope of duties
Escrow agent can call for funding of buyer’s
loan but does not have authority to discuss
inspection results or order repairs.
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Termination of Escrow
Escrow will terminate when:
 transaction closes
 escrow instructions aren’t fulfilled by
closing date (or within reasonable time, if
no closing date specified), or
 buyer and seller mutually agree to
termination
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Termination of Escrow
Escrow does not terminate:
 unilaterally (action by only one party)
 by death or incapacity of either party
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Termination of Escrow
Interpleader
Sometimes when transaction fails to close,
disputes will arise between parties over funds
or other items placed in escrow.
 If dispute arises, escrow agent should file
interpleader action and let court decide
who gets funds.
 Escrow agent should not try to decide
dispute. (Not an arbitrator.)
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Escrow Licensing
Independent escrow companies must be
licensed by California Department of
Corporations.
 Only corporation may be licensed:
 not partnership
 not individual
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Escrow Licensing
Exemptions
The following entities may provide escrow
services without escrow license:
 bank or savings and loan
 insurance company
 title company
 attorney at law
 real estate broker handling escrow for
client’s transaction
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Licensing Exemptions
Real estate brokers
Broker may provide escrow services, and
charge fees for those services, only in
transactions in which they are also
providing real estate services.
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Summary
Escrow
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Closing
Escrow
Escrow instructions
Interpleader
Independent escrow
company
• Licensing requirements
• Exemptions
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Closing Costs/Settlement Statements
Closing costs: Fees and other charges
related to real estate transaction that are
typically paid at closing.
 Particular cost may be paid by buyer or
by seller, or shared by both parties.
 Amounts may be paid to:
 other party, or
 third party.
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Settlement Statements
Settlement statement: Document that sets
forth financial details of transaction. Also
called a closing statement.
 Shows how much cash:
 buyer needs for closing
 seller will receive at closing
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Settlement Statements
Debits and credits
Debit: An amount to be paid by a party.
Credit: An amount to be paid to a party.
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Settlement Statements
Debits and credits
Closing costs paid by one party to the other
are a debit for one and a credit for the other.
 Debits and credits one party pays to or
receives from a third party are a credit or
debit to that party only.
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Settlement Statements
Debits and credits
Purchase price: Buyer’s debit and seller’s
credit.
Assumed loan: Buyer’s assumption of seller’s
loan is credit to buyer, and loan balance is a
debit to the seller.
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Settlement Statements
Debits and credits
Payoff of seller’s loan: Debit to seller.
 No entry made on buyer’s side of
settlement statement.
 Escrow agent requests beneficiary’s
statement from seller’s lender, which
states loan’s remaining principal
balance.
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Settlement Statements
Debits and credits
Seller’s reserve account: Funds the seller’s
lender required to be deposited to cover
recurring costs. Also called impound or
escrow accounts.
 Includes property taxes, insurance,
assessments, and homeowners
association fees.
 At closing unused balance is refunded,
as credit to seller.
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Summary
Settlement Statements
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Settlement statement
Credit
Debit
Purchase price
Assumed loan
Payoff of seller’s loan
Seller’s reserve account
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Prorations
Prorate: To prorate an expense is to divide and
allocate it proportionally between parties,
according to time, interest, and benefit.
Expenses commonly prorated include:
 property taxes
 mortgage interest payments
 hazard insurance premiums
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Prorations
Generally, seller is responsible for these
expenses during period of ownership but not
beyond; buyer becomes responsible for
these expenses after taking title.
Allocation of responsibility for these
expenses must be detailed in settlement
statement.
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Settlement Statements
Prorations
To prorate an expense:
 calculate daily rate of expense
(per diem rate)
 determine number of days party is
responsible for expense
 multiply number of days by per diem rate
to determine that party’s share of
expense
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Prorations
Step 1: Per diem rate
To find per diem rate:
 annual expense: divide by 365 days
(366 days in a leap year)
 monthly expense: divide by number of
days in month when closing occurs
(28, 29, 30, or 31)
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Prorations
Formulas
Although most closing agents use exact
number of calendar days, state license exam
may have questions that use simplified
“banker’s year” of 360 days (30 days each
month).
 To be completely accurate, per diem
rates should be carried to at least 4
decimal points.
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Prorations
Step 2: Number of days
Count number of days between closing date
and beginning or end of month in which
closing will occur (depending on whether
expense is buyer’s or seller’s responsibility).
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Prorations
Step 3: Rate × Days
Final step is to multiply per diem rate by
number of days, to get that party’s prorated
share.
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Prorations
Property taxes
Property taxes are:
 seller’s responsibility up to closing date
 buyer’s responsibility from closing date
and beyond
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Prorations
Property taxes
If taxes have been paid in advance:
 buyer debited for closing date and
days following that which are covered
by advance payment
 seller credited for same amount
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Prorations
Property taxes
If taxes are paid in arrears (not yet paid):
 seller debited for days before closing
date that the (buyer’s) tax payment will
cover
 buyer credited for same amount
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Prorations
Property taxes
Property taxes are levied once a year.
 In California, property tax year runs from
July 1 to June 30.
Taxes are paid in two installments:
 first installment due November 1
(covers July through December)
 second installment due February 1
(covers January through June)
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Prorating Property Taxes
Example
A transaction is closing January 20. The year’s
property tax bill was $1,752 and the seller paid the
entire amount on October 30. How much does the
buyer owe? (Use a 360-day year.)
$1,752 ÷ 360 = $4.87
Count days:
11 (Jan.) + 150 (Feb.–June, 30 × 5) = 161
$4.87 × 161 days = $784.07
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Prorations
Interest payments
Mortgage interest is paid in arrears.
 Example: Payment made on April 1
includes interest that accrued in March.
So seller’s last mortgage payment did not
include interest for month in which closing will
take place.
 Seller must pay this interest at closing.
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Prorations
Rental income
In addition to prorating expenses, some
transactions also require proration of income
(in sale of rental property).
 Rent is usually paid in advance, so seller
must give buyer prorated share of any
advance rent (for time past closing).
 Security deposits are not prorated.
(Seller must transfer entire security
deposit to buyer at closing, as lease
continues.)
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Settlement Statements
Cash at closing
To determine balance due to seller (amount
seller will take away from closing):
 add up all of seller’s credits
 add up all of seller’s debits
 subtract seller’s debits from seller’s
credits
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Settlement Statements
Cash at closing
To calculate balance due from buyer (cash
needed for closing):
 add up all of buyer’s credits
 add up all of buyer’s debits
 subtract buyer’s credits from buyer’s debits
Balance due from buyer is entered in buyer’s
credit column.
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Settlement Statements
Final balances
Buyer’s column totals don’t have to match
seller’s column totals; in fact, they virtually
never will.
 It’s as if each party has his own
checkbook, and each checkbook must be
balanced separately.
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Summary
Prorations and Cash at Closing
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Proration
Per diem rate
Prepaid interest
Balance due from buyer
Balance due to seller
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Tax Aspects of Closing
Nearly all real estate transactions have tax
implications for parties, but certain
requirements must be taken care of at time
transaction closes.
 Escrow agents must assure compliance
with:
 1099-S reporting rule
 FIRPTA
 California Withholding Law
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Tax Aspects of Closing
1099-S reporting
The closing agent has primary responsibility
for reporting every sale of real property to
Internal Revenue Service.
Information is reported on Form 1099-S,
which includes:
 seller’s name and social security number
 gross sale proceeds
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Tax Aspects of Closing
1099-S reporting
Although escrow agent has primary
responsibility for 1099-S reporting, if escrow
agent fails to report to IRS, mortgage lender
is required to do so.
 If lender also fails to report sale, it
becomes real estate broker’s duty to file
1099-S form.
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Tax Aspects of Closing
FIRPTA
Foreign Investment in Real Property Tax Act:
Federal law designed to prevent foreign
investors from evading tax liability from sale of
U.S. real estate.
 Buyer must determine if seller is “foreign
person” (not U.S. citizen or resident alien).
 If “foreign” sale, buyer must withhold 10%
of sales price and forward to IRS (escrow
agent usually handles).
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Tax Aspects of Closing
California withholding law
California also has law that requires buyers to
withhold funds for tax purposes.
 To comply with this law, buyer or escrow
agent must withhold 3.33% of total sales
price and send funds to Franchise Tax
Board.
 Some transactions are exempt.
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RESPA
Real Estate Settlement Procedures Act
(RESPA): Federal law regulating closing
process for most residential transactions. Law
is intended to:
 give homebuyers information about
closing costs that will help them compare
costs and shop for settlement services
 eliminate kickbacks and unnecessary fees
that increase costs for consumers
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RESPA
Federally related loans
RESPA applies to any federally related loan
transaction that is not exempt.
 Loan is “federally related” if it meets two
requirements:
 secured by (certain) real property
 connected to federal government
(federally regulated, insured, etc.)
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RESPA
Federally related loans
The loan is secured by mortgage or deed of
trust against:
 property on which there is (or which loan
proceeds will build) a dwelling with four
units or less,
 condominium unit or co-op apartment, or
 lot with mobile home, AND
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RESPA
Federally related loans
The lender:
 is federally regulated,
 has federally insured accounts,
 is assisted by federal government,
 makes or sells loans in connection with
federal program (Fannie Mae, Ginnie Mae,
etc.), or
 makes real estate loans totaling more than
$1,000,000 per year.
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RESPA
Federally related loans
Most institutional home loans are covered by
RESPA.
 RESPA doesn’t apply to seller-financed
transactions.
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RESPA
Requirements
Within 3 business days of loan application,
lender must give loan applicant:

HUD booklet that explains RESPA, closing
costs, and settlement statements

good faith estimate of closing costs (GFE)

mortgage servicing disclosure statement
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RESPA
Requirements
If lender or other settlement service provider
requires borrower to use particular appraiser
or other service provider, that must be
disclosed to borrower when loan application is
signed.
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RESPA
Requirements
Any referral to affiliated service provider
requires disclosure of the joint business
relationship.
Disclosure must include:
 fee estimate
 statement that the referral is optional
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RESPA
Requirements
Closing agent must itemize all closing costs
on Uniform Settlement Statement.
 Statement must be given to buyer, seller,
and lender on or before closing date.
 Buyer (borrower) must be allowed to
inspect statement at least one business
day before closing.
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RESPA
Requirements
If lender requires borrower to make deposits
into reserve (impound) account, RESPA
prohibits requiring excessive amounts.
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RESPA
Prohibitions
Lenders and all other settlement providers are
prohibited from:
 Paying/receiving fees or kickbacks for
customer referrals
 accepting unearned fees (for services not
actually provided)
 charging fee for preparation of:
 Uniform Settlement Statement
 escrow account statement
 Truth in Lending Act disclosure form
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RESPA
Prohibitions
Seller may not require buyer to use
particular title company.
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Summary
Legal and Tax Aspects of Closing
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1099-S reporting
FIRPTA
California withholding law
RESPA
Federally related loan
RESPA requirements
and prohibitions
© 2010 Rockwell Publishing