OVERVIEW
The purchase or sale of a home is often the largest single transaction that an individual will enter into over his/her lifetime. Real estate transactions involve many legal issues, including taxes, financing considerations, insurance and title examination, to name a few. The technical aspects of a real estate transaction are often complicated; this section will provide a general understanding of the nature of the transaction and its legal implications.
“Real Property” includes land and whatever is erected or growing on it together with anything connected to it that is permanently fixed and immovable. This generally includes the land and everything under it, including minerals and water, any growing crops and the air space over the land. A “home” includes single-family dwellings, townhouses, condominiums and cooperatives.
People buy homes for a variety of reasons. A home purchase generally fixes the monthly payment that the homeowner will make during the time he owns the property and protects the owner from the types of increases that are characteristic of rental arrangements. Tax considerations, which will be discussed in a later section, and build-up of equity are additional benefits of home ownership.
REAL ESTATE BROKERS
Listing/Selling Brokers
Most often, buyers and sellers get together through the services of a real estate agent or broker. A real estate broker is a professional licensed by the state who is paid a fee for negotiating a real estate transaction and putting a buyer and seller together.. The ‘listing agent’ is the broker who enters into a contract with the seller and obtains authority to show the home to prospective buyers. A seller and the listing broker will enter into a “listing agreement” which defines the relationship and spells out the amount of commission that the broker will receive if the property is sold due to the broker’s efforts. The listing broker may ultimately also be the “selling broker”, that is, the agent who actually locates a buyer. Listing brokers will often place a listing with a Multiple Listing Service (MLS) to alert other brokers that a home is being offered for sale. If a broker other than a listing broker sells the property, commissions will be divided between the two. Sales commissions are often 5-7% of the sales price.
Listing Agreements
A listing agreement should indicate how long it would be in effect. Ordinarily, it is in the seller’s best interests to enter into the shortest-term agreement possible to protect him/her from an unproductive real estate agent. A listing agreement should also set out the seller’s asking price, the amount of the agent’s commission and what the agent’s rights and responsibilities are. For example, the listing agreement may require the agent to advertise the property in newspapers at the agent’s cost. There are three basic types of listings:
Exclusive Right to Sell
Under an ‘exclusive right to sell’ listing, the listing agent earns all or a portion of his/her commission irrespective of who sells the property, i.e., even if the sale is made privately by the owner.
Exclusive Listing
In an exclusive listing, the owner is generally entitled to sell the property privately without incurring any obligation for commissions to the real estate agent.
Open Listing
An open listing is non-exclusive and accordingly, such listings can be given to multiple brokers. Whichever broker sells the property is entitled to a commission. If the owner of the property sells it privately, there is no obligation for commissions.
When Commissions Are Due
Ordinarily, under law and pursuant to the listing agreement, a broker is entitled to commission if he/she secures a buyer “ready, willing and able” to purchase the property for the price and terms set forth in the listing agreement. This means that if the real estate agent finds a suitable buyer and the seller thereafter elects not to proceed with the transaction, a commission will nevertheless be due.
After Expiration of Listing
If a real estate agent has introduced a buyer to the seller and a contract for purchase and sales is entered into after the listing agreement has expired, the seller is ordinarily still obligated to pay a real estate commission. Many a seller who has tried to avoid paying commissions by contacting a purchaser previously introduced by the broker has discovered that brokers monitor prior listings very carefully in order to protect their fees.
DISCLOSURES BY SELLER
State law, and in some instances, federal law, requires sellers to disclose any structural defects and any other problems with property offered for sale to a prospective purchaser. Real estate agents may likewise be required to make disclosures to a prospective buyer. A real estate agent should advise a seller what disclosure requirements must be complied with. Failure to make a full and complete disclosure is often the basis for litigation between buyers and sellers.
BINDERS AND CONTRACTS
Binders
Occasionally, brokers will advise a perspective buyer or seller to enter into a contract called a “binder” or “memorandum”. These binders are often determined to be legally enforceable contracts, especially when they spell out the essential terms of the transaction such as the names of the parties, a description of the property, the purchase price and the method of payment. Binders should not be signed without legal advice.
Contracts (For Purchase and Sale)
The terms of the binder, if one has been executed, and in any event the ultimate terms of the transaction, will be incorporated into a final contract, generally referred to as a ‘contract for purchase and sale’. The contract of sale should contain all of the relevant terms and conditions of the transaction. Often, real estate agents will utilize a Board of Realtor approved contract and present it to the seller and buyer. Neither party should execute any contract without competent legal advice.
Oral Agreements
Generally, any oral agreements not incorporated in the final contract are unenforceable. Contracts for the sale and purchase of real estate must be in writing to be binding pursuant to a rule of law commonly called the ‘statute of frauds’.
Necessary Contract Provisions
At a minimum, the contract for purchase and sale should contain provisions covering the following:
- A legal description (street address and the plat or survey information contained in the public records)
- The purchase price
- The amount of the deposit or earnest money, including a provision for the return or other disposition of the earnest money should either party fail to perform
- The type of deed that will be used to convey title to the property to the buyer (the various types of deeds are discussed in a later section)
- Whether the property is being sold ‘as is’ (the buyer takes the property in its present condition) or whether the seller is making representations about the condition of the property and appliances
- What repairs the seller must make to the property prior to closing and the maximum amount the seller will be required to pay for repairs
- What inspections the buyer is entitled to (e.g. roof and termite)
- A closing date (the date the title will be transferred)
- Whether the transaction is contingent or dependent upon the buyer obtaining financing
- Whether the buyer has a right to a final walk-through prior to closing.
- Deposit Money
- Ordinarily, the contract for purchase and sale will indicate that any deposit moneys will be retained by the seller as liquidated (agreed as to amount) damages should the buyer fail to live up to the terms of the contract.
Inspections
A contract for purchase and sales usually provides for various inspections to be performed at the expense of the buyer. These inspections may include a roof inspection, termite inspection, structural inspection as well as plumbing and electric inspections. If defects are determined to exist, the seller will be responsible to make repairs up to the amount specified in the contract for purchase and sale. The seller will want a “cap”, or maximum amount, that he/she will have to pay for any repairs disclosed during inspections. If the cost of repairs will exceed the amount specified in the contract, the parties can either re-negotiate a new contract or cancel the prior contract.
“As Is”
Property can also be sold “as is”. If property is sold “as is”, the buyer takes the risk of later finding out repairs are necessary. If a seller insists an “as is” sale, this should raise a red flag. A purchaser who agrees to take property “as is” should negotiate a substantial discount in the purchase price.
MORTGAGES
A mortgage is a transfer or conveyance of property as security for a loan. The ‘mortgagor’ is the borrower/owner/purchaser of the land who gives the mortgage; the ‘mortgagee’ is the person or entity that lends the money and takes the mortgage as security. Mortgages create a lien against the property; they make the owner’s title subject to the rights of the mortgagee. Mortgages are ordinarily accompanied by a promissory note, which is evidence of the debt and sets out the amount of the debt and repayment terms. Mortgages can be “first mortgages” in which case they are superior to and must be paid before any other mortgages on the property, or second, third, etc. mortgages, which are inferior to first mortgages.
Finding a Lender
Savings and Loans, Banks, mortgage bankers and credit unions are all sources for obtaining a mortgage loan. Mortgage loan brokers specialize in locating mortgage financing for homebuyers; while ordinarily the broker’s fee is paid by the lending institution, there may be additional charges to the borrower. Prevailing residential mortgage loan interest rates are published in various newspapers and journals. A prudent borrower will diligently ‘shop’ a loan through various sources.
FHA and VA Loans
The Federal Housing Administration (FHA) and the Veteran’s Administration (VA) offer federally insured loans to qualified homebuyers. FHA loans are subject to various conditions, including income requirements and minimum deposits, they are, however, less expensive than conventional mortgages. VA loans are available to qualified veterans. The Veteran’s Administration and the Federal Housing Administration can be contacted for their latest rates and requirements.
Mortgage Contingency Clause
If the purchaser of property intends to finance the transaction, he/she should insist that the contract for purchase and sale include a provision that makes the purchase contingent (dependent) on being able to obtain a mortgage. If the purchaser cannot obtain a mortgage after a good faith effort, the contract is cancelled and the deposit moneys are refunded. Absent such a provision, if the purchaser fails to secure financing, he/she may lose the deposit.
TITLE TO REAL ESTATE
Title Search
Homebuyers should retain an attorney or title insurance company to represent them at the real estate closing to assure that the buyer is acquiring good and marketable title to the property. Every piece of property has a recorded history, often dating back several hundred years. When a purchaser buys real estate, a title search is performed to determine whether the seller really owns the property and to discover any liens that may have been placed on the property. An attorney or title company will examine the ‘chain of title’- the history of purchases, sales and liens related to the property, sometimes going back to colonial times. Occasionally, a title search will disclose a mortgage that was never discharged; it may disclose that necessary parties did not join in earlier deeds and that the title is defective. If the title turns out to be defective, the seller will be required to take steps to “clear the title”.
Clearing Title
An action to ‘clear’ or ‘quiet’ title is a lawsuit that is instituted to obtain a court determination that the homeowner’s title is good and superior to any other claims against the property. If an action to quiet title must be brought because of a title defect, the closing may be delayed for several months.
Title Insurance
Title insurance is an agreement by an insurance company that it will defend and pay losses suffered by a property owner as a result of a defect in title to real property. An insurance company that has issued a title insurance policy will hire an attorney, at no cost to the homeowner, to obtain documents, signatures and releases that are necessary to clear a defective title. In rare instances, the chain of title may include a forged deed and the homeowner may lose the property. In such circumstances, the title insurance company will reimburse the homeowner for the cost of the property. The cost of title insurance is generally a small percentage (less than 1%) of the purchase price. The premium is paid only once, at the time of closing. Frequently, a lending institution that finances a real estate transaction will require the borrower to secure and pay for a title insurance policy insuring the property to the full amount of the loan to protect the lender. This type of policy is referred to as a “lender’s title policy”. Title insurance policies are written by Title Companies and by many private attorneys.
CONDOMINIUMS AND COOPERATIVES
‘Condominium’ is the term for a form of ownership of real estate in which a buyer acquires title to an apartment or unit in a multi-dwelling building and receives a right to use common areas, such as the recreational area. Condominiums are purchased in the same way as private homes and may be financed with a mortgage. A purchaser of a condominium must be pre-approved by a condominium board, however, under federal law, a buyer cannot be rejected by reason of race, color, religion or place of natural origin. Condominiums have complex rules and regulations that all owners must observe. Monthly maintenance fees are collected from the condominium board to maintain the common areas. Periodic assessments may be levied against unit owners to pay for major expenses.
In a ‘cooperative’, a purchaser acquires shares of stock in a corporation that owns a building. The stock allows the purchaser to make use of common areas and provides an exclusive lease for a specific apartment. A governing board sets policy and rules for operation of the building. It is more difficult to obtain financing to purchase shares in a cooperative as the buyer does not acquire a real estate interest and therefore may not be able to obtain a mortgage.
FORMS OF OWNERSHIP (DEEDS)
Deeds
Purchasers of real property can hold title in different ways. The deed will reflect how title to property is taken. Other than taking title to property in an individual name, there are two principle forms in which title may be held.
Joint Tenancy
When title is held jointly, the parties named in the deed agree that if one of them dies, the other will acquire exclusive title to the property. The deed will indicate that the property is owned by “a and b jointly”. Where property is held jointly by a husband and wife, they are “tenants by the entireties”. A joint tenant cannot sell his/her interest in jointly held property without a ‘partition action’, that is, a court proceeding dividing interests and authorizing the sale.
Community Property States
In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) property that was purchased while parties were married belongs to the husband and wife equally, no matter whose money actually paid for it and regardless of whether both names are on the title.
Tenancy in Common
Under this form of ownership, each party named in the deed has absolute title to their percentage share of property. The deed will ordinarily indicate that the owners are “a and b, as tenants in common. The interest of each individual tenant in common may devised by will or sold without permission of the other tenant in common.
Quitclaim Deeds
Most real estate contracts require the seller to deliver to the buyer a “Warranty Deed”, a deed that affirmatively guarantees that the seller has good and marketable title to the property being sold. Occasionally, a buyer will receive and accept a “quitclaim Deed” which merely transfers the seller’s interest in the property to the buyer without promising that the title is good and marketable. “Good and Marketable Title” means that the title is generally acceptable without objection. A quitclaim deed is rarely used in conventional real estate transactions; it is generally used for transfers between family members, gifts of property, or in the context of a divorce proceeding where one party is ordered or agrees to convey the marital home to a former spouse.
CLOSING
Time of the Essence
After the purchase and sale agreement has been signed, the title examination has been performed, inspections of the premises are completed, and financing is in place, the parties will proceed with the closing (completion) of the transaction. Many contracts contain a provision which specifies that “time is of the essence”. This provision means that any acts required by the contract, including the closing, must be performed within a specified time; failure to perform at the specified time will be treated as a breach of contract.
Closing Procedure
The closing may be held at the offices of the lender or the lender’s attorney, at the offices of the buyer or seller’s attorney, or at such other location as is appropriate under local custom. At the closing, the purchaser will sign all necessary mortgage documents if a mortgage has been obtained. The seller’s attorney or closing agent will present the purchaser with an executed deed conveying the property to the purchaser and a bill of sale for any personal property, such as furniture and furnishings, which is being sold with the property. The mortgage lender will deliver to the seller at the closing, or shortly thereafter, the proceeds of the mortgage loan. The purchaser will pay to the seller any funds necessary to close the transaction, that is, all sums of money due to the seller after the mortgage proceeds and deposits have been deducted from the purchase price. The purchaser’s attorney or closing agent will record the buyer’s deed to reflect a change of ownership in the public records. Any brokerage or agent commissions will also be paid at the time of the closing from the seller’s share of the proceeds. Ordinarily, the seller will prepare and sign an affidavit stating that there are no undisclosed liens on the property.
Escrow Closing
Occasionally, a closing will be held in escrow. In an escrow closing, an escrow agent or trustee may hold funds or a deed for safekeeping pending the performance of additional acts by either the seller or purchaser. For example, if roof repairs for which the seller was to pay $1,000.00 have not been made, the purchaser will ordinarily insist that $1,000.00 be held in escrow to guarantee payment of the repairs.
Attorney’s Fees
Attorney’s fees for representing a seller or purchaser in a real estate transaction vary from locale to locale. Often, the purchaser’s attorney is an authorized agent of a title company and will issue a title insurance policy. If the purchaser secures title insurance, the purchaser will be required to pay the premium on the policy. Generally, for an uncomplicated transaction, the seller’s attorney’s fees will be less than 1% of the sales price. The purchaser’s attorney’s fees may be 2% of the sales price or more depending on whether the buyer purchases title insurance.
Closing Costs
In addition to attorney’s fees, there are other costs or expenses that are incurred in a real estate transaction. Some of these costs include appraisals, inspections, recording fees (charges by the state or county for recording a mortgage or deed in the public records) and taxes.
Prorations
Prepaid items are prorated at the closing, that is, a portion of the expense will be credited to the buyer or the seller. Property taxes and utility charges will be pro-rated. For example, the property tax bill may be due on December 31st; if the property is sold on June 30th the seller will owe the buyer one-half of the annual tax bill for the period the seller occupied the property, since taxes will be paid 6 months later.
Capital Gains Taxes
A seller must pay a capital gains tax on any profit derived from the sale of a home unless the seller purchases another home within 2 years of the sale. For sellers who are at least 55 years of age, there is a one-time capital gains tax exemption of $125,000 on the sale of the home. If a new home is purchased within 24 months, the purchaser can defer paying any capital gains tax and can also use any difference in price between the homes to renovate the new home. This provision applies only to a primary residence. The seller is required to file an informational form with Internal Revenue Service disclosing the net price of the home