Millions of homes are sold each year and the overwhelming majority are marketed through professional real estate brokers. It might seem as though real estate brokers are paid when they list and sell homes but technically that’s not quite the case, something which has created a stir in California and a controversy which is likely to spread nationwide.
A broker obtains the right to sell a home through what is called a “listing” agreement. Depending on the jurisdiction, that agreement can spell out various issues including the sale price of the property, how the broker will be compensated and the length of the contract.
However, the broker’s compensation is not actually tied to the sale of the property in most cases. Instead an agreement might say that a fee is earned, due and payable when “a buyer is procured who is ready, willing and able to buy the property at the price and on the terms stated herein, or on any other price and terms agreeable to sellers.”
For decades such language has been defined within the real estate community to mean that a commission is earned once a ready, willing, and able purchaser has been found who will offer to pay the listing price or lower price if that is acceptable to the property owner.
In other words, it is possible for a broker to be entitled to commission upon the receipt of a full-price offer — even if the home is not actually sold. The logic is that if a broker has found a buyer who is willing to make an offer for property at the price set by an owner than the broker has done his or her job.
While it is understandable that brokers would want to be protected for the work that they do, the ready, willing and able concept raises some questions. For example, in the ethics classes that I teach I have had real estate licensees who have argued that they have no obligation to the owner once an offer has been accepted, meaning their job is done and they do not have to help get the property to closing. Others disagree.
Now, in California, this dispute has gone to an appeals court and the seller has won. The result, according to Bob Hunt at Realty Times, is that the California Association of Realtors has revised its standardized contract to say that a commission can only be earned when a home sale has actually closed.
In RealPro, Inc. v. Smith Residual Company, a court ruled that getting an offer at the full listing price is not enough to earn a commission because of the “or” in the listing agreement, the part about other terms and conditions that a seller might required.
“Notably absent from the listing agreement is language that allows for payment of any commissions simply upon the receipt of a full price offer,” said the court. It also raised four other points:
First, “a seller would not have the option to accept a higher offer on acceptable terms without still owing a commission to a broker who presented a concurrent unacceptable offer.”
Second, “a seller would be responsible to pay multiple commissions on all submitted full price offers, irrespective of the offers’ terms.”
Third, “a seller would be responsible to pay a broker’s commission if the purchaser breached before the sale was consummated simply because the broker had procured a buyer willing to purchase the property for the listing price.”
Fourth, “prospective buyer’s brokers would have no incentive to obtain purchase prices below the listing price because it would jeopardize the broker’s right to a commission.”
The California decision is likely to reverberate around the country. The idea of relating brokerage commissions to the actual sale of the property is certainly the intent of sellers and the new California language aligns the goals of brokers and sellers more closely, an idea which is likely to spread to other states.
Since January 1st, 2010, all real estate transactions have been settled using a new HUD-1. The HUD-1 is a standardized form which allows real estate buyers and sellers to clearly understand the costs of their transaction.
The original HUD-1 was developed as a by-product of the Real Estate Settlement and Procedures Act of 1974 — or, as it’s usually called, RESPA. Prior to 1974 settlement forms could be different, meaning that it was very difficult to compare costs or to know what was deductible for tax purposes in the year of the transaction.
So what do we get after 36 years? The new HUD-1 is a vast improvement over the old model. It’s three letter-sized pages long rather than two legal pages, but there’s much more information in the new HUD-1. Buried in the form is an accounting of closing costs and perhaps even some write-offs. Buyers will find the full and complete cost of buying real estate while sellers will see how much cash (if any) they’re getting from the transaction.
The first page of the form is a summary of the transaction. In effect, it translates the sales contract between buyers and sellers into hard numbers.
At the top of the form we first have administrative data such as:
- The type of loan (conventional, VA, FHA, etc.).
- The place and date of settlement (the date can be very important for tax purposes).
- The mortgage insurance case number (important if you’re ever facing foreclosure).
- The street address of the property. This is a concern because for great clarity and assurance the form would be better if it also included the legal address of the property.
- The name of the settlement (or closing) agent. The party that conducts the settlement is typically regarded as an agent of the settlement process. In other words, they do not represent you.
Page One, Buyer’s Side
The HUD-1 shows transaction costs for both buyers and sellers — you get to see what the other person’s information. More important you get to see your own.
On the right side of the first page we have buyer costs grouped by sections.
Section 100 — This is where buyers see the cost of the property and the cost of settlement (the figure found on line 1400). Combine the two and you get the gross amount — but not the final amount — due from the purchaser.
Notice that there can be some adjustments in this section. For instance, it may be that the seller has paid local property taxes in advance — those payments would be a credit to the seller and a cost at closing to the buyer.
Section 200 — As a buyer you may have certain credits to offset your gross costs. Credits include such things as your deposit, your new loan (for closing purposes the mortgage is a credit to the borrower because it represents money brought into closing) and any additional financing.
In the 200 section you can also see adjustments which are a credit to the buyer. For instance, maybe the seller still owes some property taxes.
Section 300 — This is a re-cap of all costs and credits. If you take the gross amount due from borrower (line 120) and subtract the buyer’s credits and cash you then get the total cash due to — or from — the borrower.
Most buyers, of course, will need to bring “cash” to settlement. By “cash” what most settlement agents really want is a certified check or a cashier’s check. Also, it may be possible to wire funds to the closing agent. Always ask the settlement provider well in advance of closing how payment can be made.
Gifts: To assure lenders that you are not somehow getting a secret loan from someone, it’s best to have closing funds in your name and on deposit for at least 90 days. If you are getting a gift to close, ask your lender how the gift is to be documented and precisely follow the lender’s instructions.
Page One, Seller’s Side
Settlement is a moment of truth for owners, the time when you find out exactly how much or how little you’re getting from your sale.
Section 400 — The sale price of the house, plus the cash paid for any personal items, are shown here as credits to the owner.
Also in this section are adjustments — credits for property taxes and other costs paid in advance.
Section 500 — If any mortgage debt remains unpaid it shows up here as a cost to the seller. Also, the costs of closing (line 1400) are here as a deduction as well as any adjustments for such costs as unpaid property taxes.
Section 600 — If we take the gross amount due to seller (line 420) and subtract the seller’s closing costs (line 520) we can then see how much cash the owner will get from closing (or, how much cash is needed to close if the seller is upside-down).
Practices around the country regarding cash to owners at closing vary. In some areas there are “wet” settlements where the owner gets a check at closing, in other areas there are “dry” closings where it takes a few days to get a check because it takes time for the lender to fund the transaction and paperwork to be recorded. In some jurisdictions there are rules requiring the disbursement of cash with a few days. For specifics, speak with your settlement agent.
On the second page of the new HUD-1 we have a series of sections which show costs that may be paid by either buyers or sellers — or split between them. In other words, these are costs which can be negotiated when a sale offer is made. For instance, in a slow market a seller might agree to pay all transfer taxes. In a hot market, the buyer might pay.
Section 700 — If one or more real estate brokers are involved in the transaction, this section will show the compensation to each broker and the cost, if any, to buyers and sellers.
Section 800 — Getting a mortgage is hardly free. When the buyer applied for financing the lender provided a Good Faith Estimate of Closing Costs (GFE) on the new form developed by HUD. This section shows such costs as points, origination charges, appraisal fee, credit report and tax service. Borrowers should check the numbers at closing with the estimates provided in the GFE. The costs shown on lines 801 (origination charge), 802 (points), and 803 (adjusted origination fee) must be the same as the GFE.
Please see our guide to the new Good Faith Estimate form to see how it’s coordinated with the equally-new HUD-1.
Section 900 — Closing is scheduled at a time which is mutually-agreeable to the buyer and seller. That time, however, will mean that for such items as interest, mortgage insurance premiums and homeowner’s insurance there will likely be a need to make some payments for daily costs in advance until the next billing period.
Section 1000 — If you purchase a home with less that 20 percent down the lender will likely require that you pay additional amounts each month for property taxes and insurance. This money is held in an escrow or trust account and then paid out as the bills come due.
If you will have an escrow account then the lender will typically collect money in advance from borrowers to assure that the escrow account is properly funded.
Section 1100 — As part of the buying process, sellers typically promise to deliver good, marketable and insurable title — and buyers should want nothing less. This section shows the costs for title insurance — both lender’s and owner’s coverage.
Lender’s cover — which is required by lenders if you finance the purchase — protects you up to the remaining loan balance in the event of a title claim. In other words, it protects the lender.
Owner’s coverage protects you if there is a title claim up to the purchase price of the property — in other words the loan amount plus your equity. Be aware that some title insurance policies have an inflation rider so that the value of the coverage can actually increase over time. For specifics, speak with your title agent.
Also, take a look at line 1107. This shows the commission paid to the settlement agent for providing title insurance.
Section 1200 — This is where you can see how much state and local governments are getting from the transaction. Governments are elated when homes are sold because such transactions are a major source of revenue. Government taxes can includes such things as deeds, releases, transfer taxes, state taxes, stamps, etc. Call it what you will, a tax is a tax.
Section 1300 — This is where you can find additional settlement costs.
Section 1400 — The total costs to close — this number also appears on lines 103 and 502 on the first page.
The third page of the new HUD-1 is partially a confirmation that the costs outlined in the Good Faith Estimate are what you’re actually paying — or pretty close.
Some quoted costs on the GFE cannot be changed, some can be changed as much as 10 percent and some can simply change with the winds.
Also shown on page three is a recap of your loan including the mortgage amount, interest rate, loan term, ARM-related terms (if any), prepayment penalties (if any), balloon payments built into the loan (if any) and related matters.
IMPORTANT: Always keep your closing papers in a safe place for tax reasons and to assure that your loan terms are actually the same as disclosed on the HUD-1. For questions regarding closing issues, speak with your real estate broker, mortgage lender and closing agent. Be aware that some costs found on a HUD-1 may be tax deductible — for specifics speak with a tax professional.
Question: I bought a home with FHA financing. We have a monthly insurance premium (MIP) with each payment. How do we get rid of this cost?
Answer: When you bought your home you purchased with little money up front, perhaps 3.5 percent down. This means a lender put up as much as 96.5 percent of the purchase price. This is a high-risk situation for lenders because they greatly prefer 20 percent down.
With FHA, what you have is not a loan from the government but a form of insurance for the lender. You can borrow with little down, but you have to pay for the insurance coverage — the MIP.
You may or may not be able to end the MIP. Here are three points.
First, if you have sufficient equity you may be able to refinance without any form of mortgage insurance. Generally, you must have equity equal to 20 percent of the property or more. Speak with lenders for specifics.
Second, if your FHA loan has a case number assigned after June 3, 2013, new HUD policies state that mortgage insurance must remain in effect for the life of the loan if you purchased with less than 10 percent down. If you bought with more than 10 percent down the insurance must remain in effect for at least 11 years.
Third, for an FHA mortgage was closed on or after January 1, 2001 or has a case number issued before June 3, 2013 then the opportunity to cancel your mortgage insurance premium remains in place.
HUD states as follows:
“Effective for all loans closed on or after January 1, 2001, FHA’s annual mortgage insurance premium will automatically be canceled-once the unpaid principal balance, excluding the upfront MIP, reaches 78 percent of the lower of the initial sales price or appraised value based on the initial amortization schedule and pursuant to instructions contained in ML 00-38. Although the annual mortgage insurance premium will be canceled as described, the contract of insurance will remain in force for the loan’s full term. This mortgage insurance premium cancellation provision applies only to loans insured under the Mutual Mortgage Insurance (MMI) fund. The MMI fund does not include mortgages on condominiums or Section 203(k) rehabilitation loans, among others.”
In other words, if you had a $100,000 FHA mortgage then to discontinue the payment of monthly mortgage insurance premiums the balance would have to be less than $78,000. Speak with lenders for specifics.
Different loan programs use different calculations, or ratios, to qualify would-be borrowers.
The “front” ratio is generally equal to your monthly costs for principal, interest, property taxes, and property insurance (what lenders call “PITI”). The “back” ratio includes the front ratio plus all regular monthly costs such as credit card payments and auto payments.
For example, Hall has a household income of $6,000 a month. With a conventional loan, a lender might allow ratios of “28/36.” The front ratio is “28.” This means 28 percent of Hall’s pre-tax income can be used for principal, interest, taxes, and insurance. In this case, 28 percent of $6,000 is $1,680 per month.
The back ratio is “36.” This means lender guidelines will allow Hall to devote 36 percent of $6,000, or $2,160 a month, to PITI plus regular monthly costs for items such as credit card debt, auto payments, etc. Generally today there are few loans which allow back ratios to exceed 43 percent.
Different programs use different front and back ratios: basic FHA loans are at 31/43 while VA ratios are more liberal at 41/41. Some ARM programs use 33/38 ratios.
Program ratios can be elastic. For instance, the use of energy efficient appliances and construction can help liberalize ratios, sometimes by 2 percent. This can be important for those trying to meet qualification standards.
In recent years, lender guidelines for many programs have become more liberal — meaning that more can be borrowed with a given income. For details, speak with lenders and real estate brokers.
It sometimes happens that a property is sold or refinanced more than once within a five- or ten-year period. In such instances, if title insurance is obtained from the same firm, it’s often possible to get a re-issue (discount) rate. The discount can represent a significant savings, thus it is worthwhile to ask if such a discount is available.
How much of a discount? According to Realtor.com, the discount can be as much as 50 percent and sometimes more. My look into the practice has found more modest discounts, say 10 or 20 percent.
The American Land Title Association says that “refinance or reissue rates are discounts off the rates that would otherwise be charged to insure the transaction. The size of the discounts vary, but they can be substantial. Consumers should ask the person handling their closing if refinance or reissue rates are available.
“ALTA also recommends consumers purchase owner’s title insurance to protect their investment when purchasing a home or property. Owner’s title insurance protects the consumer’s use and enjoyment of the property. However owner’s title insurance does not need to be reissued during a refinance. It is good for as long as the owner or his/her heirs have an interest in the property.”
Long ago I interviewed a settlement attorney. He did virtually all of the closings for a builder, meaning that when the builder purchased a parcel of property the attorney obtained title insurance for the company. Then, as the builder sold off homes, new title insurance policies were issued to each purchaser. Since the attorney had done the prior title work I asked if re-issue rates had been issued to the new home buyers. It turned out that was not the case and refunds were soon issued to some 80 purchasers.
The California Land Title Association has an excellent calculator which can allow you to compare rates at: http://www.clta.titlewizard.com
Speak with your closing provider for details — as much ahead of closing as possible.