Closing Costs Flashcards
As I explained in the last chapter, a closing statement is a document that provides a detailed list of each party’s expenses as well as how much they have already contributed to the transaction thus far. The specific document that will be used for mortgage loans is known as a Closing Disclosure.
The closing statement also provides an accounting of the final amount that the buyer must bring to the closing. To complete a closing or settlement statement properly, one must know which principal is responsible for each transaction expense.
Most closing cost expenses are agreed to in the sales contract. A license holder must also have a clear understanding of credits and debits and should know how to prorate expenses that must be divided between the principals.
Closing Disclosure Form
Below is the Consumer Financial Protection Bureau’s Closing Disclosure form. Feel free to familiarize yourself with its contents.
Lenders are required to provide the Closing Disclosure to the borrower three business days before the scheduled closing. The borrower should use the time before closing to make sure all the costs align with their expectations.
You, as the agent, should help guide your client through the form if needed.
The Consumer Financial Protection Bureau’s Closing Disclosure form.
Closing Disclosure
Every real estate transaction comes with a bunch of expenses: broker fees, lender fees, title insurance, etc. Who pays them? For most expenses, it’s negotiable. A really motivated buyer or seller might agree to pay for something that isn’t usually their responsibility to sweeten the deal. Those negotiations will happen before the contract is signed, and the results will be spelled out in the contract.
Because of this, there are no set guidelines I can teach you about who pays for what. When it comes time to figure it all out for closing, the escrow officer will use the sales contract to determine how the parties have agreed to allocate the expenses.
Buyer’s Closing Costs
Even though everything is up for negotiation, there are expenses typically paid by each party. Like we talked about, this may change in some transactions, but traditionally, here’s what a buyer pays for:
Appraisal fees: The party that ordered the appraisal usually pays the fees associated with that appraisal, and generally, the buyer orders the appraisal. This is paid by the buyer because it is required by the lender in order to get loan approval.
Attorney fees: In Arizona, most simple real estate transactions don’t require the help of a lawyer — the two agents and the escrow officer figure it all out. However, if one of the parties wants or needs a lawyer, they’ll be the one to pay their fee.
Condo or co-op fees: These are assessments that are used to help pay for maintenance of common areas and other co-op- or condo-related items. The buyer might owe the seller an adjusted amount based on the time the buyer uses the services.
Escrow fee: That escrow officer does a lot of hard work, and they don’t do it out of the goodness of their heart! The escrow fee is based on the purchase price and is typically split equally between buyer and seller.
HOA transfer fees: Many properties are part of a homeowners association, or HOA. Typically, the HOA charges a fee ($200-$400) to transfer the property. This is traditionally split evenly between buyer and seller.
Homeowners insurance: Like we talked about in the last chapter, the buyer will need to pre-pay for a year of homeowners insurance (sometimes called hazard insurance) and, if it’s required, flood insurance.
Home warranty: It will say in the contract whether the buyer or the seller pays for the home warranty.
Loan fees: A buyer is usually responsible for paying loan origination fees for a new loan, and for paying assumption fees if they assume the seller’s existing loan.
Recording fee: Thanks to a 2008 law passed in Arizona, there’s a flat $30 fee to record a deed and an affidavit of value. The buyer will pay the recording fee for documents in their name(s).
Survey fees: A buyer usually pays property survey fees, especially if they obtain a new mortgage. If all parties agree, then a previous survey may be used as long as the seller can produce the old survey and signs a statement that, to the best of their knowledge, nothing has changed since the survey was done. The buyer’s attorney and the lender do not have to accept the old survey.
Tax and insurance reserves: A buyer is often required to open an escrow account to cover real estate taxes that are assessed during the time the transaction is taking place. In this case, they generally deposit at least enough in the account to pay for the taxes through the end of the month of closing. However, a seller is debited and a buyer is credited for any of the seller’s unpaid taxes. A buyer often also pays at least the first year’s premium on fire or hazard insurance at closing.
Title expenses: There are two types of title insurance policies: lender’s (mortgage loan) policies, and owner’s (fee or purchase) policies. In Arizona, it’s typical for the buyer to pay for the lender’s policy and the seller to pay for the owner’s policy.
Allocating Expenses
A seller will typically be responsible for these costs:
Their attorney’s fees: Again, it’s not typical to use a lawyer but if the seller hires one, they will pay them.
Broker’s commission: A commission is usually paid out as a percentage of the property’s sales price, and it’s negotiated and paid by the seller. The agreed-upon commission percentage will be explicitly stated in the listing contract.
Condo or co-op fees: These are assessments that are used to help pay for maintenance of common areas and other co-op- or condo-related items. Before the closing, a seller must bring their account up to date.
Escrow fee: Usually, the seller will pay the other half of the escrow fee.
HOA transfer fees: Again, it’s typical for sellers to pay half of the HOA transfer fee. However, this can be negotiated and would more than likely be the buyer paying the fee.
Home warranty: Sometimes the seller pays for the home warranty, sometimes the buyer does. It will be negotiated before signing the contract and included in the contract.
Recording fee: Any documents recorded in the seller’s name are paid for by the seller. Again, a new law mandates recording fees in Arizona are a flat $30.
Satisfying existing liens: A seller will need to take on the expense of satisfying any existing lien on the property. In most cases, there is at least a mortgage lien that the seller will pay off with a portion of the buyer’s lender’s funds. If the lender charges an early payoff fee, that’s the responsibility of the seller.
Termite inspection fee: Even though the buyer pays for the general inspection, it’s traditional in Arizona for the seller to pay for the termite inspection. The seller will also pay to fix any bug problems the inspector finds. Yeek.
Title expenses: Generally, a seller is required to pay for the title search. However, if a buyer conducts another search of their own, then they usually pay for that additional research. It’s typical in Arizona for the seller to pay for the owner’s title insurance, but it is negotiable.
Seller’s Closing Costs
Let’s break down those closing costs a little more. Closing costs can be classified as either recurring or non-recurring. Recurring costs are costs that will be paid for again, even after closing, usually annually. These include things like property taxes, flood insurance, and property insurance.
Non-recurring closing costs, on the other hand, are paid for only once. Non-recurring costs make up the bulk of closing costs, and they may be divided into two categories:
Those that are associated with the home-purchase process, such as title and inspection fees
Those that are associated with the lender, such as the loan origination fee
Closing Costs
Non-recurring closing costs associated with the home purchase process (and NOT the lender) include:
Courier fee: the costs associated with delivering documents to the buyer, seller, lender, title company, law firm, county recorder, and so on to facilitate the closing process
Escrow fee: fee paid to the escrow officer
Home inspection fee: fee a home buyer must pay if they did not pay it at the time the home was inspected
Homeowners’ association transfer fee: fee charged by a homeowners’ association for transferring all of their ownership documents to the new owner
Home warranty: optional fee paid for an insurance policy covering items such as major appliances; not to be confused with a warranty provided by the builder of a new home that would cover the structure itself
Legal or document preparation fee: fee paid to a lawyer or law firm for preparation of legal documents for transaction and lender-required forms, may also be paid to the lender for documents prepared in-house.
Notary fees: fee for forms that must be attested to, or notarized
Pest inspection/treatment: fee for inspection or treatment and repairs of pest infestations, wood rot, and water damage (as a lender may require as a precondition of procuring the loan)
Recording fees: fee for recording legal documents with a local county recorder
Title insurance: assurance to the potential homeowner that they are receiving clear title to the property being purchased, free of liens and encumbrances, as well as discrepancies in boundaries and area, if a survey was done
Home-Purchase-Process Closing Costs
The non-recurring closing costs associated with the lender are collected only at closing and do not continue to be collected during the loan period. The exact amount of each fee should appear on the Closing Disclosure. Non-recurring closing costs associated with lender include:
Administration fee: additional fee sometimes charged by a lender to establish the loan
Appraisal review fee: fee sometimes charged by a lender for a second appraiser to review the original appraisal when findings are considered questionable
Appraisal fee: fee paid to a licensed/certified real estate appraiser, usually by the lender, to appraise the value of the property
Assumption fee: fee charged by the lender for allowing the assumption of a loan by another party and forgiving the original borrower’s obligation
Credit report fee: fee paid to a credit reporting service for reviewing the borrower’s credit history
Escrow waiver fee: fee paid when an escrow account is not being established
Flood certification fee: fee for a service hired to determine whether a property is located in a federally designated flood zone
Flood monitoring: fee paid to a service to maintain monitoring on whether flood remapping affects a property
Loan origination fee: a point is equal to one percent of the loan amount — this amount is paid directly to the lender as a fee to set up the loan
Mortgage broker fee: broker processing fees. Sometimes there are several of these under different names since some brokers have other “fees” listed that are beyond the scope of this course. The fees are sometimes referred to as “junk fees” since the fee covers nothing but netting more money for the mortgage broker. Agents need to have their borrowers ask questions about this fee (or fees) to the broker directly since some of these are negotiable and can be reduced or eliminated.
Tax service fee: fee for a service that checks to make sure property tax payments are made or have been made
Underwriting fee: fee sometimes charged by lender if reselling the loan in the secondary market
Wire transfer fee: fee charged if funds are wire transferred at closing for a buyer or seller
Warehousing fee: fee charged by the lender as an additional amount for establishing the loan
Lender-Related Closing Costs
In general, what the Closing Disclosure does is provide a detailed accounting of each party’s debits and credits.
Credits
A credit is a positive balance or a positive amount. For our purposes, it is a figure entered in a party’s favor when determining the overall costs associated with a transaction.
On the Closing Disclosure, credits reflect expenses that have been paid by a particular individual or expenses that are owed to that individual.
Debits
A debit is a negative balance or a negative amount. For the purposes of our discussion, a debit is an amount due from or owed by a particular individual when determining the overall costs associated with a transaction. On the Closing Disclosure, debits reflect charges made to the parties involved in the transaction.
The actual amount that a buyer is to pay at closing is calculated by subtracting the buyer’s total credits (such as prepaid earnest money or the balance of a loan that the buyer will assume from the seller) from the buyer’s total debits (such as the purchase price). The remaining total is the amount that the buyer must bring to the closing to complete the transaction.
A Visual Guide to Credits and Debits
A table outlining the effects of credits and debits on buyers and sellers.
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An Earnest Example
An easy example of a credit is a buyer who prepays earnest money.
Earnest money is a deposit made to a seller showing the buyer’s good faith in regards to the future performance of a sales contract. In almost all instances, a buyer pays an earnest money deposit at the time the purchase contract is negotiated.
So, at closing, the buyer receives a credit for the money that they already have prepaid.
Net to Seller
To determine how much money a seller will receive from a transaction, the net to seller, we subtract the seller’s total credits (such as the balance of a mortgage loan and closing costs) from the seller’s total debits (such as the purchase price). The remaining total is the amount that the seller will receive.
Seller’s credits - Seller’s debits = Net to seller
EXAMPLE
Susie is selling her home. At closing, she has some debits, including paying for a title search, agent commission, and paying off the remaining amount of her loan. All together, her debits equal $100,000. She also has a number of credits, including prorated HOA fees and taxes, and most importantly, the buyer’s purchase price. Her credits equal $250,000. If you subtract her credits of $250,000 by the debits of $100,000, you get the net to seller. In this case, Susie’s net profit on the transaction is $150,000.
In most cases, when we are tallying up credits and debits, it will be clear which party is responsible for a given transaction expense. However, some expenses cannot be allocated so easily.
Many items that are prepaid or paid for at the end of the year, such as taxes, need to be divided proportionately between a buyer and a seller. The process of making this proportional division is called proration.
Credits and Debits
When a person sells a property, it’s important to fairly divide up the ongoing expenses to ensure that neither the seller nor the buyer is paying for time they didn’t occupy the property. It’s not fair to ask the seller to pay for a whole year of taxes, for example, if they only owned the property for half of the year.
Some expenses, like HOA dues, are paid at the first of the year. Others, like mortgage interest, might be paid at the end of the year (in arrears).
In every case, these expenses need to be split fairly between the buyer and seller of the property. This is done through a process known as proration. Proration is the act of dividing or allocating expenses between buyers and sellers based on the actual period of usage of the item or service.
Accrued Items
Accrued items are costs that have been incurred, but have not been paid for yet. Accrued costs are owed by a seller (such as some recurring special assessments and mortgage interest), but which will ultimately be paid by a buyer after they receive title to a property. That is to say, these expenses have been (or are being) incurred at the time of sale, but need not be paid at the time the sale closes.
In an effort to ensure that these expenses are handled fairly, the seller generally pays the buyer for these items through credits at closing. For example, a seller might credit a buyer for the proportion of a special assessment that was charged during the part of the year that the seller occupied the property.
Prepaid Items
A prepaid item is an item that has been paid for ahead of time, generally by the seller. For example, a seller might have prepaid an insurance policy that is required by the local homeowner’s association. A buyer must then generally “purchase” this item from the seller at the time of the sale, either with cash, credits, or in some other way that the principals have negotiated.
Accrued items are generally debited to the seller and credited to the buyer.
Prepaid items are credited to the seller and debited to the buyer.
Prorated Expenses
There are many different expenses that might need to be prorated at closing. These can include:
Real estate taxes
Special assessments (a government-levied charge to a geographic area to fund a public project)
HOA dues
Fuel
Water and sewer charges
Rent (if a rental property is being sold)
Security deposits
Rent
If a rental property is being sold, the buyer is given a prorated amount of the rent owed to them. Remember that tenants pay their rent for the next month (in advance). So if the seller has already collected rent for the month of the closing, the buyer is entitled to a prorated amount of the monthly rent starting with the day escrow closes.
Proration
Let’s imagine a sale closing June 14, with an HOA bill of $30 for the month of June. How would that work?
Prorate to the Closing Date
The accrued and prepaid items should be calculated to the closing date. It should be laid out in the contract which party is responsible for expenses on closing day. In this example, the buyer starts to pay the expenses on closing day per the contract.
Proration Calendar
Here’s how that proration would look:
A calendar illustrating the proration schedule in the previous example.
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To calculate the prorated expenses, we divided the $30 by the 30 days in the month of June to find that the cost of the HOA bill was $1 per day. The seller paid $13 for the first 13 days, and the buyer paid the remaining $17 for the remaining 17 days.
Proration Example
When calculating prorated expenses, the first step is determining an annual charge for the item being prorated. This amount is then divided by 12 to calculate the monthly charge for the item. It may be necessary to go further and calculate a daily charge for the item. In this case, there are two methods commonly used to calculate daily charges:
A 360-day year: The 360-day year is known as a “banker’s year”; it is commonly used in banking to make calculations easier. That way, the year is cleanly divided into 12 months of 30 days each. To figure daily charges using a 360-day year, you can divide the yearly charge by 360 or divide the monthly charge by 30.
A 365-day year: The 365-day year is sometimes also called the “conventional calendar year,” because its divisions reflect the actual months of the calendar that most of us use. To calculate the daily charge for an item using the conventional calendar year, divide the yearly charge by 365 (366 in a leap year).
The actual number of days or months in the period for which you are calculating the prorated expense is then multiplied by the monthly or daily charge (whichever is appropriate) to determine the accrued amount or prepaid amount for the item.
What You Need to Know
Before you begin calculating prorations, then, you will need to answer the following questions:
What kind of item is being prorated? Is the charge for the item assessed daily, monthly, annually, or according to some other schedule?
Is this item accrued or prepaid?
Which calculation method should be used?
Where is my calculator? 😮
The 360-Day Year
Quick note: Throughout this section of the course, we will use the 360-day year. However, the “traditional” rules about how prorations are calculated and who pays for the closing date might change depending on where you are. In general, the contract will spell it out.
Calculating Prorated Expenses
Let’s practice prorating an accrued item.
Here’s the story: A sale is to be closed on the second of July. The property’s water bill for the entire year has been estimated at $300, and is paid at the end of the year (so, it’s accrued). According to the contract, the seller is responsible for expenses on the day of closing. Therefore, the seller’s accrued period is six months (January through June) and two days (July first and second). This is the amount of time for which the seller should be held responsible for the property’s water bill, because the seller occupied or was otherwise responsible for the property during this time.
Let’s calculate the prorated cost for the water bill, using a 360-day year.
Step 1: Find the monthly expense for water.
Take the annual bill ($300) and divide it by 12 months.
Annual bill ÷ 12 months = Monthly water bill
Plug in our numbers:
$300 ÷ 12 months = $25 a month
Answer: The water bill is $25 a month.
Step 2: Find the daily expense for water.
Take the monthly expense ($25) and divide it by 30 days.
Monthly expense ÷ Days in month = Daily water bill
Plug in our numbers (and remember, we’re using 30-day months):
$25 ÷ 30 = $0.83 per day
Answer: The seller will pay $0.83 per day for water.
Step 3: Multiply to find the monthly expense
To find the total monthly expenses, we take the six months the seller owes and multiply by our monthly water bill cost, $25.
Answer: $25 x 6 months = $150
Step 4: Multiply to find the daily expense
Multiply our daily cost ($0.83) by the days the seller owned the property in July (2).
Answer: $0.83 x 2 = $1.66
Step 5: Add the monthly and daily amounts
$150 + $1.66 = $151.66
Final Answer: $151.66 should be credited to the buyer and debited to the seller as we calculate the various settlement expenses associated with the transaction.
Math Practice: Prorating an Accrued Item
When calculating prorated expenses for a prepaid item, it is first necessary to determine the period of time for which the expense has been prepaid.
For example, let’s assume that a seller lives in a state in which real estate taxes are prepaid. They have prepaid all real estate taxes for the year 2019 up to and including December 31st. The total amount of prepaid taxes is $2,000. The sale’s closing date is October 5, 2019.
Using a 360-day year, we can calculate the number of prepaid months and days beyond the closing date as follows:
As we noted, the total paid was $2,000. Now that we know the number of prepaid months and days beyond the closing date, we can calculate the amount that will be credited to the seller and debited to the buyer.
Step 1: Find the monthly tax bill
To find the monthly tax bill, we divide the total by 12 months.
Annual bill ÷ 12 months = Monthly tax bill
And here’s the formula with this scenario’s numbers plugged in:
$2,000 ÷ 12 months = $166.67
Answer: The monthly tax bill is $166.67.
Step 2: Find the daily tax bill
Then we find the daily tax bill, using a 30-day month because we’re working with a 360-day year.
Monthly tax bill ÷ Days in month = Daily tax bill
And here is the formula with this scenario’s numbers plugged in:
$166.67 ÷ 30 days = $5.56
Answer: This gives us a total of $5.56 for the daily bill.
Step 3: Multiply and add
You need to multiply the monthly bill by the number of months the buyer will own the home, the daily bill by the number of days the buyer will own the home, then add the two together.
Remember, because this bill was prepaid by the seller, we’re trying to find out how much the buyer owes. Since they’re closing on October 5, we count the two months of November and December and the 25 remaining days in October (30-day months! No Halloween!).
Here’s what the equation looks like:
(Monthly bill x 2 months) + (Daily bill x 25 days) = Prorated tax bill
And here’s what it looks like with the numbers plugged in:
($166.67 x 2 months) + ($5.56 x 25 days) = $472.34
Final Answer: The prorated tax bill is $472.34.
Credit to the Seller
This is the total amount that the seller has prepaid beyond the closing date – that is, the seller has paid $472.34 in taxes for a period during which the buyer should be held responsible for these charges. This amount will be credited to the seller and debited to the buyer as we calculate the various settlement expenses associated with the transaction.
Prorating a Prepaid Item
Let’s go through a whole transaction and look at all the debits and credits and where they would go. Remember that you wouldn’t be doing this in real life, it would be the job of the escrow officer. We’ll work through one together, then you’ll have some to answer on your own.
Marcel and Lena’s Closing
Marcel is selling his home to Lena. It’s a charming three-bed, three-bath in Tucson. Congrats to you, Lena. It’s a great place!
Here are some things to know about the deal:
According to the contract, close of escrow will be on November 14. It states the buyer pays for closing day.
The purchase price is $255,000.
Lena made a $2,500 deposit when she signed the contract.
Escrow fees are $400.
Owner’s title policy is $1,250.
Lender’s title policy is $800.
Total property tax for the year is $1,620. In real life, property tax in Arizona is levied twice a year, in arrears (which you know from an earlier level!). But to make our lives easier, let’s compute the property tax prorations as though the whole year is paid at once at the end of the year, in arrears.
HOA transfer fee is $300 and is going to be split between the parties, per the contract.
Marcel’s broker is being paid 6% of the purchase price.
The $30 recording fee is being paid by the buyer.
There are $2,700 in lender fees, including origination fees, notary fees, etc.
For prorations, we’ll use the 360-day banker’s year.
one party paying credits to another with cash
Solving for Credits and Debits
Let’s look at these one at a time together to determine what should be credited and debited to the buyer and seller.
Purchase Price
The purchase price is a credit to the seller, and a debit to the buyer. Makes sense, right? The buyer is paying the purchase price to the seller.
Deposit
This one’s a bit tricky. The deposit is a credit to the buyer, because she’s already paid it. It’s being held by the escrow officer, so it’s credited to her at closing.
Escrow Fees
The $400 escrow fee is split between the buyer and seller. So that’s a $200 debit to the buyer and a $200 debit to the seller.
Owner’s Title Policy
Remember that the seller typically pays the owner’s title policy, so that is a $1,250 debit to the seller. Note that while it’s a debit to the seller, it’s not a credit to the buyer — the money is going to the title company, so it’s not going to offset the amount Lena owes.
Lender’s Title Policy
The buyer pays for the lender’s title policy: $800 debit to the buyer, Lena.
Taxes
Taxes need to be prorated so that the buyer and seller only pay for the portion of the year they owned the property. The taxes are $1,620, paid in arrears. Close of escrow is November 14, and the buyer owns closing day. Do you remember how to calculate the proration?
Step 1: Divide by 12 to find the monthly cost
$1,620 ÷ 12 = $135
Answer: Taxes were $135 a month.
Step 2: Divide by 30 to find the daily cost
$135 ÷ 30 = $4.5
Answer: Taxes were $4.50 a day.
Step 3: Find the prorated amount
So the seller owned the home from January 1 to November 13. We multiply the monthly cost $135 by 10(months), then the daily cost $4.50 by 13(days), then add the two together.
$135 x 10 + $1,350
$4.50 x 13 = $58.50
$1,350 + $58.50 = $1,408.50
Answer: The seller owes $1,408.50 in taxes for the year of the sale.
Step 4: Determine if it’s a debit or credit
Because in this example the taxes are paid at the end of the year by the buyer, the taxes the seller owes will be debited to them.
Final Answer: Debit $1,408.50 to the seller for taxes.
HOA Transfer Fee
The HOA transfer fee will be split evenly. That’s a $150 debit to both the buyer and the seller.
Commission
The sales price of the home was $255,000 and Marcel agreed to pay a 6% commission, so:
$255,000 x 0.06 = $15,300
Marcel will be debited $15,300 for commissions.
Recording Fee
The buyer is paying the recording fee, so that’s a $30 debit to her. It’s not credited to Marcel because it is not being paid to him, it’s being paid to the county.
Lender Fees
Finally, there’s a debit of $2,700 in lender fees to the buyer, Lena. She will pay those fees to the lender, so there is no corresponding credit to Marcel.
Escrow Settlement Scenario
