A typical real estate transaction requires accounting for the expenses incurred by either party, generally on the HUD-1, a form required for any federally related closing. All expenses must be itemized to arrive at the exact amount of cash required from the buyer and the net proceeds to the seller. These include prorated items those prepaid by the sellers for which they must be reimbursed and expenses the seller has incurred but for which the buyer will be charged.
How the Closing Statement Works
The completion of a closing statement involves an accounting of the parties’ debits and credits. A debit is an amount that a party owes and must pay at closing. A credit is an amount entered in a person’s favor, an amount that has already been paid, an amount being reimbursed, or an amount the buyer promises to pay in the form of a loan.
A debit is an amount to be paid by the buyer or seller, A credit is an amount payable to the buyer or seller.
A similar procedure is followed to determine how much money the seller actually will receive. The seller’s debits and credits are each totaled. The credits include the purchase price plus the buyer’s share of any prorated items that the seller has prepaid. The seller’s debits include expenses, the seller’s share of prorated items to be paid later by the buyer, and the balance of any mortgage loan or other lien that the seller pays off. Finally, the total of the seller’s debits is subtracted from the total credits to arrive at the amount the seller will receive.
Broker’s commission The responsibility for paying the broker’s commission will have been determined by previous agreement. If the broker is the agent for the seller, the seller normally is responsible for paying the commission. If an agency agreement exists between a broker and the buyer, or if two agents are involved, one for the seller and one for the buyer, the commission may be distributed as an expense between both parties or according to some other arrangement.
Attorney’s fees If either of the parties’ attorneys will be paid from the closing proceeds, that party will be charged with the expense in the closing statement. This expense may include fees for the preparation or review of documents or for representing the parties at settlement.
Recording expenses The seller usually pays for recording charges (filing fees) necessary to clear all defects and furnish the purchaser with a marketable tide. Items customarily charged to the seller include the recording of release deeds or satisfaction of mortgages, quitclaim deeds, affidavits, and satisfaction of mechanics’ liens. The buyer pays for recording charges that arise from the actual transfer of title. Usually, such items include recording the deed that conveys title to the purchaser and a mortgage or deed of trust executed by the buyer.
Transfer tax Most states require some form of transfer tax, conveyance fee, or tax stamps on real estate conveyances.
In Illinois, state and county transfer taxes are usually paid by the seller in accordance with most sales contracts. Local ordinances usually establish which party is responsible for paying municipal transfer taxes.
Title expenses Responsibility for title expenses varies according to local custom. In most areas, the seller is required to furnish evidence of good title and pay for the title search. If the buyer’s attorney inspects the evidence or if the buyer purchases a title insurance policy, the buyer is charged for the expense.
Because the seller usually is required by the contract to furnish evidence of good title, the seller customarily pays for the owner’s title insurance policy. The buyer customarily pays for the lender’s policy, which ensures that the lender has a valid first lien.
Loan fees The discussion of loan fees becomes even more critical with the new good-faith estimate form associated with the new HUD-1 form. For a new loan, the lender generally charges an origination fee and possibly discount points if the borrower wants a below-market interest rate. These lender charges for taking, underwriting, and processing the loan application, including points and origination fees, may not increase prior to closing. If they do, the lender may elect to reissue a new GFE, thereby triggering a three-day waiting period to closing (to allow the buyer time to “shop” for a new loan) or to “correct” the problem with a reimbursement within 30 days of closing. If the buyer assumes the seller’s existing financing, the buyer may be required to pay an assumption fee. Also, under the terms of some mortgage loans, the seller may be required to pay a prepayment charge or penalty for paying off the mortgage loan before its due date.
Tax reserves and insurance reserves (escrow or impound accounts) Most mortgage lenders require that borrowers provide reserve funds or escrow accounts to pay future real estate taxes and mortgage insurance premiums. A borrower starts the account at closing by depositing funds to cover at least the amount of unpaid real estate taxes from the date of lien to the end of the current month. (The buyer receives a credit from the seller at closing for any unpaid taxes.) Afterward, an amount equal to one month’s portion of the estimated taxes and mortgage insurance, if applicable, is included in the borrower’s monthly mortgage payment.
The borrower is responsible for maintaining adequate fire or hazard insurance as a condition of the mortgage loan. Generally, the first year’s premium is paid in full at closing. An amount equal to one month’s premium is paid after that. The borrower’s monthly loan payment includes the principal and interest on the loan, plus one-twelfth of the estimated taxes and insurance (PITI). The taxes and insurance are held by the lender in the escrow or impound account until the bills are due.
IN PRACTICE RESPA permits lenders to maintain a cushion equal to one-sixth of the total estimated amount of annual taxes and insurance. However, if state law or mortgage documents allow for a smaller cushion, the lesser amount prevails.
Appraisal fees The purchaser usually pays the appraisal fees. When the buyer obtains a mortgage, it is customary for the lender to require an appraisal, and the buyer bears the cost. If the fee is paid at the time of the loan application, it is reflected on the closing statement as already having been paid.
Survey fees The purchaser who obtains new mortgage financing customarily pays the survey fees. The sales contract may require the seller to furnish a survey. Lenders usually require a new spot survey.
Most real estate contracts in Illinois require that the seller furnish a current survey to the buyer. As a result, the expense of preparing a survey usually is borne by the seller.
Additional fees An FHA borrower owes a lump sum for payment of the mortgage insurance premium (MIP) if it is not financed as part of the loan. A VA mortgagor pays a funding fee directly to the VA at closing. If a conventional loan carries private mortgage insurance, the buyer prepays one year’s insurance premium at closing.
Accounting for Expenses
Expenses paid out of the closing proceeds are debited only to the party making the payment. Occasionally, an expense item, such as an escrow fee, a settlement fee, or a transfer tax, may be shared by the buyer and the seller. In this case, each party is debited for its share of the expense.
