A typical real estate closing has a lot of paperwork, but there are two short and simple pieces of paperwork that are key components to any residential or commercial real estate transaction.
The first important paper is the Settlement Statement. For decades, it was referred to as the HUD-1. After the Dodd-Frank reforms came into place, the HUD-1 went away, and the Settlement Statement took its place. There are some who believe, as I do, that the HUD-1 conveyed valuable information in a way that was easier to read than the Settlement Statement.
It is crucial that you review the preliminary Settlement Statement and follow the money as it moves through the transaction. Don’t be afraid to ask questions of the escrow officer, title attorney or whomever is handling the transaction. Expect to see an estimated Settlement Statement that will give you a projection as to what the closing will look like; but since no one knows for certain the final costs and exact date of closing until it actually occurs, there will often be a final Settlement Statement prepared post-closing that reflects the accurate costs incurred for recording, tax prorations, rent prorations, etc.
The second and most misunderstood document in a real estate closing is something called a Closing Protection Letter. This letter is essentially an agreement from a title insurance company to a lender or other party putting money into escrow indemnifying that lender or party against any issues arising from the closing agent’s errors, fraud or negligence. The big legal word for this is “defalcation”, when a closing agent misappropriates funds, conceals the fraud, and skips town. If the closing agent would misappropriate the funds, the title insurance company has agreed in writing to make the necessary financial remediation and reimbursement. If you are putting money into escrow as a private lender or as a cash buyer, it is absolutely essential that you obtain a closing protection letter so you have a layer of insurance to protect you in the event the closing agent or one of their employees steals the money and disappears.
Speaking of theft and misappropriation of funds, I’ll share in my next email a strategy I heard that is a great tactic to prevent con artists who have hacked an email account from being able to change wiring instructions and submit new wiring information, thereby taking money from a real estate closing.