When an individual participates in a closing to buy, or sell a home or refinance their mortgage, the main reason that such a complex real estate transfer can be quickly accomplished is because an independent, third-party professional has already pulled together all of the documentation necessary to close the transaction. The closing process differs state by state and in some cases county by county, but the outcome is roughly the same in every jurisdiction.
Closing—or settlement as it is known in some parts of the country—is a term used to designate the point in time at which the contemplated transaction is concluded.
For most residential purchase and sale transactions, closing generally designates the point at which title to the property is transferred from seller to buyer, a mortgage (or "deed of trust") is given by the buyer/borrower to the lender and the funds from the buyer and lender are transferred to the seller. The closing date is typically negotiated between the buyer and the seller along with other terms when they agree to a purchase contract.
Once a closing date is selected, the parties will select a closing or settlement agent. Consumers can shop around to select a settlement agent to perform the closing functions, or they can rely on a recommendation from their real estate agent or lender.
While variances occur throughout the country, a closing agent is typically an attorney, or an employee of a title company, or escrow company. The closing agent acts as a clearinghouse collecting all the necessary documentation, including the deed, mortgage, title and homeowners insurance policies, payoffs (if there are liens on the property that must be released) and pest inspection reports. This person also handles the exchange of monies, including any earnest money deposit, mortgage funds and personal funds of the parties. Lastly, the closing agent prepares the settlement statement. The HUD-1, as it is referred to, documents all costs for both the buyer and seller associated with the closing and is required to be issued on all federally related mortgage transactions.
At closing, the property is transferred from the seller to the buyer. In most parts of the country, consumers will sign a number of documents whose content will be described by their closing agent. Finally, the settlement agent will forward payment to any previous lender, other lien holders, tax collectors, municipalities and pay all of the other parties who performed services in connection with their closing, pay out any net funds to the seller, and order a final search of the title to their new home before finally recording all of the documents needed to complete their purchase.
This process can be daunting, but thanks to the efforts of closing agents and the American property rights recording system, transactions are most often closed in 30-45 days after signing the purchase agreement. It is worth highlighting that the United States enjoys one of the fastest transaction times in the world due to this public private partnership.
In 1974, Congress passed the Real Estate Settlement Procedures Act. In Section 1 of RESPA, Congress declared that, “significant reforms in the real estate settlement process are needed to insure that consumers throughout the nation are provided with greater and more timely information on the nature and costs of the settlement process and are protected from unnecessarily high settlement charges caused by certain abusive practices that have developed in some areas of the country.”
A similar sentiment was expressed when Congress passed the Truth in Lending Act in 1968. For mortgage transactions, these acts mandate a two-part regime of providing consumers with an early disclosure and a late disclosure of loan and settlement costs. This regulatory requirement has fundamentally shaped how mortgages are originated today.
Within three days of applying for a mortgage, consumers receive two disclosures, an estimate of their loan terms and an estimate of the closing costs (called the good-faith estimate). These documents are designed to help consumers shop for their mortgage by giving them estimates of their mortgage and closing costs that they can compare between competing lenders. On the current good-faith estimate, HUD includes a “shopping chart” to help assist consumers in comparing mortgage offers. However, despite the focus on consumer shopping, these early disclosures often are insufficient to help consumers shop because the form masks certain charges by reflecting only a combined cost number for several services, or “rollup,” which ultimately makes it more difficult for consumers to shop effectively for individual services.
After picking a loan product, consumers receive final disclosures at the closing table which outline the actual loan terms and the final closing costs called the Uniform Settlement Statement or HUD-1. Recent reforms have turned the HUD-1 from a simple disbursement sheet outlining all the fees paid at closing into a comparison document to help consumers compare their GFE and HUD-1 to assess the accuracy of the estimate and ask informed questions about whether costs changed and, if so, why they changed.
While these are the main disclosures given to consumers, other federal, state and local laws require that consumers be provided a myriad of additional disclosures at closing.
In conducting closings, ALTA members find that consumers benefit most from disclosures that provide them with tools to more fully understand their individual transaction. ALTA would like to make the following recommendations to improve federal mortgage disclosures to ensure consumers receive the information needed for them to shop for their mortgage and settlement services.
Improving transparency by itemizing costs will help consumers understand their entire transaction. One significant change to the RESPA disclosures adopted in November 2008 and implemented in January 2010 was the introduction of “roll-up” lines and aggregate line item totals on the HUD-1 Settlement Statement. This concept was designed to help consumers shop for settlement services by making it simpler to aggregate classes of charges. While the stated goal was improving consumer understanding of charges, roll-ups have not been an effective tool for achieving this goal. Rather, our experience has found that transparency, simplicity and itemization of charges is a more effective solution for consumers.
In the current forms, roll-ups lump fees into aggregate standard categories. Consumers are then encouraged to shop based on these aggregates. Alongside or underneath the aggregate, some (but not all) fees are itemized. Thus, consumers are given a disclosure that includes an aggregate fee that may not reconcile with an addition of the itemized fees listed underneath or alongside.
ALTA members routinely see the confusion this causes for consumers who are unable to reconcile the numbers on the page. A better solution would be to return the itemization and transparency from the previous GFE and HUD-1. Just like when you go out to dinner, your check doesn't just give you a total price. Rather, each item is listed giving you a breakdown of what you pay for. These forms would allow consumers to see where their money is going and to better inquire regarding fees they find questionable.
Itemization would also help consumers shop. Greater transparency of the source of costs helps consumers see what costs are included in the cash needed to close. This level of transparency offers a better opportunity for consumers to shop for these additional services by providing them detailed information to use when going to other providers to obtain competing bids. This level of detail and transparency promotes competition among providers, thus avoiding excessive fees and promoting a realistic picture of the transaction. Finally, this level of detail promotes consumer education by allowing consumers to look inside their transaction and have a better understanding of the fees they incur for various services.
Consumers' ability to shop for their mortgage and settlement services is improved when the estimates provided are accurate. However, we have found that attempts to tie initial estimates to final costs through the use of tolerances have not resulted in consumers receiving accurate estimates.
Currently, two categories of fee estimates are subject to restrictions on their increase from the numbers originally shown in the GFE. The first, which includes a lender's own charges and government transfer taxes, may not increase by any amount at closing. This category is often referred to as “zero tolerance”. The second category includes services required by the lender where the provider is not selected by borrower lender. These costs, in the aggregate, may not increase by any more than 10% at closing. Should costs increase in excess of the tolerance allowance, a payment must be made by the lender of the amount in excess of the allowed tolerance.
While designed to provide more accurate disclosures, tolerances have had the opposite effect. To avoid a tolerance violation, some providers overestimate fees within their control that are subject to tolerance. These overestimations allow providers to ensure that even if some fees outside of their control increase, there will be a sufficient buffer to prevent a tolerance violation. Even if a tolerance violation occurs, many consumers express surprise at the prospect of the refund, and show no understanding of the tolerance concept.
Another way that some providers avoid tolerances is by issuing multiple initial disclosures during the transaction. Since only the most recent GFE is disclosed to the settlement agent for the computation of tolerances, these “magic GFEs” (as they are called in the industry) typically appear numerous times throughout the process to update the estimates to avoid a violation. The volume and frequency of the issuance of these “magic GFEs” (even though currently either prohibited or severely restricted by current RESPA regulations) have led some consumers to admit to ALTA members that they do not even open the new disclosures that they receive.
The effect of these practices is that tolerances are not necessarily resulting in more accurate estimates at the time of application or improved consumer comprehension. Thus, they fall short of their intended purpose.
Anne Anastasi is president of Genesis Abstract in Hatboro, Pa., and also serves as the president of the American Land Title Association.
