Chapter 14: Real Estate-Related Computations & Closing of Transactions

Question 1

Closing

Answer 1

The closing of a real estate transaction is the final act that concludes the contract between the buyer and seller. All money due is paid, all costs are allocated and paid, and title is conveyed to the buyer. The settlement of a real estate transaction occurs when the seller delivers the deed to the buyer, and the buyer pays the seller the amount agreed upon for the purchase of the property. Typically, a real estate settlement is called a closing. On the day of closing, all accounting in the transaction is finalized.

Question 2

Who conducts closings?

Answer 2

Title companies, attorneys, and real estate brokers conduct closings. Real estate licensees must be capable of explaining the closing process to the parties with whom they deal. Since most buyers and sellers may be involved in the purchase or sale of property only a few times in their lives, they will be uncertain about the process. Various steps must be taken to close a real estate transaction, including obtaining evidence of the seller’s ownership, securing mortgage loan information, completing property inspections, obtaining property insurance, itemizing costs and expenses for the buyer and seller, and preparing legal documents.

Question 3

Federal Government Requirements for Real Estate Settlement Reporting

Answer 3

Effective August 5, 1997, the Taxpayer Relief Act of 1997 changed the rules for Internal Revenue Service reporting requirements related to real estate transactions.

Closing agents handling title transfers involving the sale of principal residences with gross sales prices of $500,000 or less for married couples or below $250,000 for single taxpayers do not need to file IRS Form 1099 that indicates the name and address of each party to the transaction.

Question 4

Preclosing Activities

Answer 4

After a purchase and sale contract has been negotiated between the buyer and seller, many details must be handled prior to the day of closing. The seller must clear any title problems and arrange for preparation of the deed that will transfer ownership. Usually, the seller provides either an abstract of title or a title insurance policy as evidence of a merchantable title.

Question 5

Preclosing Activities for buyer

Answer 5

The buyer must conclude financial arrangements, and perform necessary property inspections and title examination. This process can be time-consuming as unforeseen problems can occur.

Question 6

Preclosing Activities for Licensees

Answer 6

Licensees often create checklists to ensure that all tasks and responsibilities are handled in a timely manner and that nothing is overlooked. In addition to the list of items to do, there should also be a place for the scheduled date, the actual date when the responsibility was met or completed, and the initials of the person who completed the task. A good checklist will help to ensure that nothing is missed along the way and all requirements are met in a timely manner. The contract, company policy, legal requirements, and local customs in your area dictate what goes into the checklist.

Question 7

Copies of the contract

Answer 7

the buyer, seller, cooperating broker, title closing agent, and lender must receive legible, clean copies of the fully executed contract.

Question 8

MLS Status

Answer 8

should be kept current to reflect the changing states of the listing.

Question 9

Loan Application

Answer 9

the buyers need to submit a loan application within the time frame specified, unless they are paying cash.

Question 10

Inspection and Insurance

Answer 10

any inspection and homeowner hazard insurance need to be ordered and completed.

Question 11

Contingencies

Answer 11

may need to be cleared, such as inspection, appraisal, and loan approval.

Question 12

Repairs

Answer 12

later on in the process, the sellers may need to schedule repair work identified in the inspection and arrange access for such work.

Question 13

Closing Agent

Answer 13

the clients may need to select a closing agent, if the sellers had not already done this at the time they signed the listing agreement. The closing agent will require certain information and copies of some documents, such as a copy of the seller’s deed, previous title insurance policy, and existing mortgage information. It is helpful if the sellers have the survey from when they purchased.

Question 14

Utilities

Answer 14

coordination between the sellers and the buyers is helpful when arranging for the switching over of the utilities effective the day of closing.

Question 15

Closing Date and Location

Answer 15

near the end of the process, the appropriate associate should inform the parties of the time and place of the closing.

Question 16

Walk-Through

Answer 16

inspection of the property should be scheduled.

Question 17

Escrow Funds

Answer 17

any escrowed (earnest money) funds must be delivered to the closing agent.

Question 18

Closing Statements

Answer 18

The purpose of a closing statement is to summarize the transaction as of the day of closing. It is where the seller learns how much money they will “take away” from the closing and the buyer learns how much money they must bring to the closing.
Each charge or receipt is listed individually so the parties can verify the amounts.
The sales contract addresses who will pay for each item, and if nothing is negotiated to the contrary, the charges will be assessed as stated in the contract. This is known as allocating the charges according to custom.

Question 19

What are the three major parts to a closing statement worksheet?

Answer 19

1. Seller’s Statement
2. Buyer’s Statement
3. Broker’s Statement

Question 20

The Buyer’s and Seller’s Statement each contain what two columns?

Answer 20

Debit and Credit

Question 21

Debit column closing statement

Answer 21

the second letter of the word debit is “e” for expense.

Question 22

Credit column closing statement

Answer 22

the second letter of the word credit is “r” for receipt.

Question 23

The Broker’s Statement contains

Answer 23

The Broker’s Statement contains a receipts and disbursements column in place of debits and credits. The Broker’s Statement derives its name from years past when brokers closed their own transactions and accounted for the funds. Today, closing or title companies offer closing services to brokerage companies and make the necessary disbursements at closing.

Question 24

Whenever a debt (left-hand column)

Answer 24

is made to the seller, a corresponding credit (right-hang column) for the same amount must be made to the buyer.

If the buyer is not to receive those monies, it is entered in the disbursement column (right-hand column) on the Broker’s Statement.

Question 25

For every amount entered as a left-handed entry

Answer 25

the same amount has a corresponding right-hand entry. This allows the Grand Totals on the bottom of the Broker’s Statement to balance when the worksheet is complete and assures the closing company that all numbers were entered appropriately.

Question 26

Single-entry

Answer 26

A single-entry item affects only one party and appears only on that party’s statement as either a debit or a credit.

Question 27

Double-entry

Answer 27

item affects both parties and appears on both statements; however, a double-entry item is always a charge or debit to one party and a credit or benefit to the other party.

Question 28

Prorations

Answer 28

are expenses and receipts (debits and credits) that are divided proportionately between the buyer and seller. All entries in the Prorations and Prepayments section are always double-line entries.

Question 29

Example of prorations

Answer 29

An example would be the real estate taxes (city, county, on lines 16 and 17). Taxes are paid for each calendar year, from January 1st of the current year to December 31st. In Florida, when property tax bills are mailed on November 1st, they go to the property owner of record who is responsible to pay for the entire year. This is called paying taxes in arrears.

If a closing takes place in July, the seller has not received the current year’s tax bill yet. At closing, the real estate taxes are collected from the seller for the portion through the closing day and given to the buyer so that they can pay the taxes for the entire year when due. This amount would be recorded in the Prorations and Prepayments section as a debit to the seller and a credit to the buyer.

Question 30

Who determines the actual form used?

Answer 30

The closing agent determines the actual form used, and is required to use the Closing Disclosure form required by RESPA for residential transactions financed by a federally regulated lender.

Question 31

Seller’s Net Sheet

Answer 31

When listing or selling property, potential sellers and buyers are anxious to know how their decision will affect them financially. Licensees will usually prepare a net sheet that illustrates the costs and charges that will be incurred to assist them in making their decisions.
Since the legal and financial consequences are significant and the closing process is complex, a licensee can often provide valuable assistance at closing by helping to explain the process to members of the public with whom they deal.

Question 32

Total Purchase Price

Answer 32

Since the total purchase price is paid to the seller, it is entered as a credit on the seller’s statement.

The totally purchase price is entered as a debit (or charge) on the buyer’s statement because the buyer must pay that amount for the property.

Question 33

Seller’s Debit Column

Answer 33

The seller’s debit column can be explained as a portion of the sales price the seller does not receive on the day of closing.

These items reduce the amount the seller will receive at closing.

Question 34

Buyer’s Credit Column

Answer 34

The buyer’s credit column represents money the buyer does not need to bring to the closing table.

These items reduce the amount of the purchase price that remains to be paid on the day of closing.

Question 35

Binder Deposit

Answer 35

When the contract was first entered into, the buyer pays a binder, or earnest money deposit. The broker usually holds this deposit in an escrow account until the day of closing.

Since the seller has not yet received this money, it is not shown on the seller’s portion of the closing statement. The seller is still owed the entire amount of the purchase price. A check is drawn in the amount of the deposit, which the broker brings to the closing and delivers to the closing agent.

On the closing statement, the binder deposit is entered as a credit to the buyer since this portion of the purchase price has already been paid and will not have to be paid again.

Only when earnest money is paid to the seller prior to closing, the earnest money (binder) deposit would appear as a debit to the seller.

In that event, since the earnest money deposit is a part of the purchase price, the seller would not receive this amount again at closing. Therefore, the amount the seller receives at closing would be reduced by the deposit amount already received.

Question 36

When the Buyer Assumes the Mortgage

Answer 36

If the buyer is assuming a mortgage, the buyer receives a credit. This amount does not have to be paid on the day of closing and reduces the amount of the purchase price remaining to be paid. Likewise, the seller will not receive this portion of the sales price, so the amount being assumed is a debit on the seller’s statement.

Question 37

When the Seller Agrees to Finance a Portion of the Purchase Price

Answer 37

If the seller agreed to finance a portion of the purchase price (second mortgage), the closing statement will reflect a credit to the buyer and a debit to the seller. This is a portion of the purchase price the buyer will not have to pay on the day of closing, and a portion the seller will not receive.

Question 38

When the Buyer Obtains a New Loan

Answer 38

If the buyer arranges new financing from an outside lender, which does not involve the seller, the closing statement would reflect a credit to the buyer. This amount reduces the money needed to conclude the closing. The amount of the loan does not appear on the seller’s statement, as the seller did not participate in the loan. The lender will forward the proceeds of the loan to the closing agent.

Question 39

When the Seller Pays Off an Existing Loan

Answer 39

If the seller were paying off an existing mortgage loan, the seller’s closing statement would reflect a debit to the seller. The proceeds the seller receives are reduced by this amount.

Question 40

Prorating

Answer 40

Prorating is the division of items that cover time periods during which both the seller and the buyer own the property. These must be proportionately divided between the buyer and seller based on the amount of time each owns the property.

All prorations are entered as a double-entry in the closing statement, since one party will have to pay the other some money at closing. If the proration requires the seller to be debited, the same amount must appear as a credit to the buyer and vice versa.

Question 41

Day of Closing

Answer 41

All prorations are calculated as of midnight. In that way, a day does not have to be divided into hours or minutes, which would make the calculations more complex.

The day of closing, by agreement, is allocated either entirely to the seller or to the buyer, regardless of the time of day in which the closing takes place. The day of closing, therefore, belongs to either the seller or the buyer for purposes of prorating.

If the day of closing is the seller’s day, prorations are calculated as of midnight on the day of closing.

If the day of closing is the buyer’s day, prorations are calculated as of midnight on the day before closing.

Question 42

The ownership periods

Answer 42

of the seller and buyer can be illustrated by using timelines that divide the item that is to be prorated into two parts: one part that represents the seller’s period of ownership, and one part that represents the buyer’s period of ownership.

Question 43

Example of day of closing ownership

Answer 43

Rent is to be prorated. The closing date is March 17. The day of closing is the seller’s day.
The seller would be allotted 17 days of ownership, since the day of closing belongs to the seller. In the same transaction, if the day of closing belonged to the buyer, the time lines would be changed so that March 17 would become a buyer’s day and the seller’s period of ownership would stop on March 16.

Question 44

Calculating Prorations

Answer 44

There are two accepted methods used for calculating prorations: the 365-day method, and the 12-month/30-day, or 360-day method. The 365-day method is generally used and would be used if the parties did not agree otherwise in the contract of sale.

Question 45

365-day Method

Answer 45

Real estate taxes, which are paid annually, are divided by 365 days to obtain the daily cost. This amount is multiplied by the number of days that are prorated to determine the amount of the proration. Rent and mortgage interest are divided by the number of days in the month of closing and multiplied by the number of days which are being prorated.

Question 46

12-month/ 30-day Method

Answer 46

This method, sometimes called the 360-day method, assumes that a year consists of 12 months with 30 days each. The amount of annual real estate taxes is divided by 12 months to obtain a monthly average cost, which is then divided by 30 to arrive at a daily average cost. All months are considered to have 30 days. To calculate the amount to be prorated, the monthly average cost is multiplied by the number of full months of ownership, and the daily average cost is multiplied by the number of days of ownership in the month of closing. These two figures are added together to obtain the total amount which is to be prorated.

Question 47

Items Subject to Proration

Answer 47

Items subject to proration include mortgage interest when a loan is being assumed, real estate taxes, insurance, and rent.
Real estate taxes are paid on an annual basis, while rent and mortgage interest are generally paid on a monthly basis. Rent is usually paid in advance, while real estate taxes and mortgage interest are generally paid in arrears.

Question 48

Prepaid Rent

Answer 48

Rent is usually paid in advance. The monthly rent was already collected by the seller for the month of closing and must be divided equitably between the seller and buyer. The seller is entitled to retain only that portion of the rent that covers the period of time the seller owned the property. The seller is debited for the amount of rent that applies to the buyer’s period of ownership; the buyer receives a credit for that amount.

Question 49

Prepayment vs. Proration

Answer 49

A prepayment, as the name suggests, is money paid in advance. When a seller agrees to take back a second mortgage, prepaid interest may be required. A prepayment is not the same as a proration. A proration equitably divides an existing obligation between the parties; a prepayment is a new obligation created at closing. When prepayments are required, the day of closing is always charged to the buyer.

Question 50

Prepaid Mortgage Interest Required by Lender for a New Loan

Answer 50

Many lenders want all payments to be due on the first of the month. If a closing occurs on any day other than the first of the month, interest for the balance of the current month must be prepaid by the buyer. This prepayment is not a proration, but simply a charge against the buyer which will appear as a single-entry debit to the buyer in the Expenses part of the closing statement, not the Prorations and Prepayments section. There would be no interest payment due on the first of the month following closing, since the interest normally paid in arrears was prepaid by the buyer at closing.

Question 51

Interest is Paid in Arrears

Answer 51

Monthly mortgage interest is typically paid in arrears.
If a buyer assumes a loan, the seller has paid no interest for the month in which the property is sold. In an amortized loan, part of every payment is applied to pay the interest on the loan for the prior month.

Question 52

Seller Owes Interest for Seller Days in the Month of Closing

Answer 52

In order to make the transaction equitable for both parties, the seller is debited for interest not paid during the month of closing, and the buyer receives credit for the same amount.

Question 53

Property Taxes

Answer 53

Property taxes are paid in arrears. The seller has paid no property taxes for the year in which the sale occurs, unless the closing takes place after November 1st and the seller paid them prior to closing. Only one tax bill per year is mailed, and that is sent to the owner of record on November 1st. The buyer will receive the tax bill for the whole year, even though the buyer did not own the property for the whole year. Therefore, the seller is debited for property taxes based on the period of the seller’s ownership, and the buyer is given credit for the amount. If the seller has paid the taxes prior to closing, the seller will be credited and the buyer will be debited.

Question 54

Closing Statement: Expenses

Answer 54

The Expenses section of the closing statement involves expenses that are owed by either the seller or the buyer to parties involved with the transaction including attorneys, the state, the title company, and the brokerage firm. Expenses are debited to either the buyer or seller. There are no credits in this section. All items in this section are single-entry only.

Question 55

Abstract Continuation

Answer 55

The abstract is a history of the title to a property. Since documents are continuously being recorded in the public record the abstract must be updated to assure that the property has a marketable title. The seller is normally expected to provide either title insurance or an abstract accompanied by an opinion of title as evidence of a marketable title. The seller cannot require the buyer to use a specific title company if the buyer is paying for title insurance.

Question 56

Title Insurance

Answer 56

Providing a marketable (clear) title is the responsibility of the seller. If the title proves to be defective, the seller would need to take the necessary legal action to clear the title before conveying the property to the buyer.
The buyer’s lender requires title insurance to be placed on the property to protect the lender’s interest in the unpaid balance of the loan. The buyer’s interest in the property can also be included in the policy to protect the buyer from any future claims against defects that were undetected when the policy was issued. Either the buyer or seller can pay for title insurance, but payment is usually the responsibility of the buyer.

Question 57

State Documentary Stamp Tax on the Deed

Answer 57

Before a deed can be recorded in the public records, documentary stamps must be purchased and affixed to the deed. Stamps are purchased from the clerk of the circuit court, usually when the deed is presented for recordation.

In the absence of any agreement to the contrary, the seller is responsible for the payment of this tax.

Currently, the tax on the deed is calculated at the rate of $0.70 per $100 of value, or fractional part thereof, based on the sales price of the property. The exception is for Miami-Dade County, where the rate is $0.60 rather than $0.70.

Question 58

State Documentary Stamp Tax on a Promissory Note

Answer 58

The state documentary stamp tax on a promissory note is calculated at the rate of $0.35 per $100 or fractional part thereof on the total amount of the note.

The state documentary stamp tax on the note is paid on both new and assumed notes. This tax is not payable if title is taken subject to the mortgage.

The buyer usually pays this tax.

Question 59

State Intangible Tax on Mortgage

Answer 59

The state intangible tax on mortgages is paid on all new mortgages only. The tax is not payable when a mortgage is being assumed or title to the property is taken subject to the mortgage. The tax is collected when mortgage documents are recorded in the public record.

The state intangible tax on a mortgage is calculated at the rate of 2 mills (.002) on the total amount of a new mortgage.

The buyer usually pays this tax.

Question 60

Attorney Fees

Answer 60

Each party must pay his or her own attorney for services provided.

Question 61

Calculating the Brokerage Fee (Commission)

Answer 61

Either party can pay the brokerage fee. One or the other, or both may be debited for the broker’s fee based on the negotiated agreement. However, the seller usually pays this fee in residential transactions.

Question 62

The Completed Closing Statement

Answer 62

The broker’s statement accounts for all money received by the closing agent and all money paid by the closing agent, shown as grand totals. These amounts must equal.

Entries are made as receipts and disbursements. (Note that all single- entry items must appear in the broker’s statement. Double-entry items never appear in the broker’s statement.)

Receipts include the earnest money held by the real estate broker, proceeds of any new third-party loans, and the balance due from the buyer. The closing agent uses the receipts to pay any money due to the parties, such as the seller, the broker, the state of Florida, the attorney, the title company, and so on. The closing agent also handles recording of the deed.