presents

The Keys to a Successful Transaction: From Qualifying Buyers to Escrow

California Department of Disclaimer Statement:

This course is approved for Continuing Education credit by the California Department of Real Estate. However, this approval does not constitute an endorsement of the views or opinions which are expressed by the course sponsor, instructor, authors or lecturers.

Introduction

Welcome to "The Keys to a Successful Transaction...." In this course we will discuss in detail some of things that you will need to know to build a successful real estate practice, including disclosure obligations, financing considerations, taxation issues, valuation preparation and the escrow process. Each of these topics is a self- contained section with an overview, study questions, and an end-of-section quiz.

Disclosure Obligations for Residential Real Estate

Overview

The California real estate industry long ago moved out of the era of "buyer beware" and into the age of disclosure. There seems to be no end to what a prospective buyer, borrower, and seller must be told about a and the financing necessary to purchase it. The law imposes obligations not only on real estate licensees but on principals to a transaction as well. Not all licensees understand, however, what is meant by "mandatory disclosure." Some do not understand why they are required to disclose certain facts. Others are not sure what specific, mandatory disclosures real estate licensees should make. This chapter will cover the many disclosures mandated by law, providing valuable information on the disclosures that must be made, to whom, by whom, in what manner, and for what reason.

Objectives

After studying this chapter, you will be able to: • Comply with agency disclosure law and other laws regarding the agency relationship • Correctly complete the agent's portion of the transfer disclosure statement, and explain the transfer disclosure statement law and form to sellers and buyers • Recognize the various circumstances in which disclosure is necessary when involved in the sale of a residential one-to-four unit • Comply with disclosure laws when financing is provided by the seller or broker • Meet requirements regarding lead-based paint disclosure • Meet requirements regarding water heater bracing, anchoring, or strapping

Key Terms/Concepts

The following are the key terms and concepts found in this chapter:

• Agency Disclosure Statement • Agency Confirmation Statement • Agency Election • Area of Potential Flooding • Broker's Duty to Inspect • Condos/Planned Developments • Death/AIDS Disclosure • Domestic Violence Shelter Disclosure • Dual Agency • Earthquake Fault Zone • Earthquake Safety (Homeowner's Guide to) • Earthquake Safety ( Owner's Guide to) • Environmental Hazards Disclosure Booklet • Exemptions from Disclosure • FHA Loans/HUD Sales • FIRPTA/California Withholding • Flood Hazard Area • Flood Disaster Insurance • Industrial Use Zone • Lead-Based Paint • Mandatory Disclosure • Material Facts • Megan's Law • Mello-Roos District • Methamphetamine Contamination Notice • Military Ordnance Location • Mold • Disclosure Statement • Natural Hazard Zone Disclosure • Seismic Hazard Zone • Seller Financing Disclosure Statement • Smoke Detector Compliance and Disclosure • Special Flood Hazard Area • State Fire Responsibility Area • Structural Pest Control Reports • Transfer Disclosure Statement • Very High Fire Hazard Severity Zone • Water Heater Bracing • 1915 Bond Act Assessments

Introduction

As you read, think about:

• The meaning of mandatory disclosure • Reasons disclosures are mandated

A mandatory disclosure is an item of information (i.e., some type of fact, data, figure, or news), which is required by law to be conveyed from one entity involved in a to another entity in that same transaction. The disclosure obligation can be imposed by federal law, the state legislature (through state statutes), local government (through local ordinances), the courts (case law), or the Department of Real Estate (through regulations that are part of the state law). Although the law does not always require disclosures to be made in writing, it is advisable that all disclosures be put in writing. Furthermore, it is highly recommended that a party obtain a signed acknowledgment of receipt of the disclosure by the other party or agent to the transaction.

Disclosure obligations are imposed by legislators for a variety of reasons. Often, disclosures are mandated out of a need to protect consumers in what usually is the single most important economic transaction of the consumer's lifetime--the purchase of a home. Also, by mandating disclosures, legislators are responding to the complaints and concerns of their home-buying and home-selling constituents. Many legislators view mandatory disclosures as a way of reducing conflict by increasing the knowledge regarding the property by all parties to a transaction.

For a complete summary in chart form of all the required real estate disclosures, please see legal memoranda, "Summary Disclosure Chart for REALTORS®" and "Sales Disclosure Chart for REALTORS®." They are available to C.A.R. members on CAR Online and are updated annually to reflect any changes in the law.

Agency Disclosures

As you read, think about:

• The three-step process of agency disclosure, election, and confirmation • The importance of disclosing dual agency • The requirement to disclose the negotiability of real estate commissions • The necessity of disclosing any direct or indirect interest a licensee has or expects to acquire in the property

Agency Disclosure, Election, and Confirmation

California Real Estate Agency Law (Civil Code Sections 2079.13 through 2079.24) requires licensees to comply with a three-step process:

1. Disclosure, 2. Election, and 3. Confirmation.

The disclosure and the confirmation must both be done in writing.

The California Real Estate Agency Law applies only to sales, exchanges, land sale contracts, or for greater than one year of residential property improved with one-to-four dwelling units, including mobilehomes and mixed use .

Agency Disclosure

The disclosure step requires a licensee to present the Agency Disclosure Statement to a principal. This disclosure is a form which describes the general duties of agents in a real estate transaction. Its function is educational. Real estate agents must understand the various types of agency to be able to discuss them with their principals. The Agency Disclosure Statement contains a specific discussion of the types of agency in which one can be involved. The exact language of this form is dictated by statute in Civil Code Section §2079.16 and may not be modified. The C.A.R. Agency Disclosure Statement form (AD) (see Appendix, p. 166) contains the language mandated by Civil Code §2079.16 on the front, and as required by Civil Code §2079.16, reprints of other agency statutes on the reverse side of the form.

Timing of the Agency Disclosure Step

The timing of the agency disclosure is dictated by law:

• The agency disclosure form must be given to the seller by the listing agent prior to the execution of the . • The agency disclosure form must be given to the buyer by the selling agent prior to the execution of the purchase offer. • Furthermore, another agency disclosure form must be given to the seller by the selling agent (unless the selling agent is also the listing agent) prior to the presentation of the purchase offer to the seller. Each principal should acknowledge receipt of the disclosure form by signing it. Copies of these executed forms should be placed in the office file.

There are three important additional considerations regarding agency disclosure:

1. For the purpose of agency disclosure, "agent" is synonymous with employing broker. This means that the name used for the agent on the disclosure and confirmation statements is the name of the company under whose license either the listing is taken or the offer to purchase is prepared. 2. Agency relationships must be consistent within an office. For example, if two salespeople work for the same broker (office) and one represents the buyer and the other represents the seller, the broker (office) is considered a dual agent. 3. The agency disclosure form has a place for the "Agent's" name and the "Associate Licensee's" name. If this form is completed by a real estate salesperson or a broker-associate working for another broker (or office), write the broker's (or office) name above the "Agent's" line; the salesperson or broker-associate will sign his or her name above the "Associate Licensee" line. Place the date next to the signature. If the form is completed by a real estate broker, the broker's name may be signed and dated above the "Agent" line. The two lines for Buyer/Seller are intended for two buyers or two sellers. Since buyers and sellers receive this form at different times during the transaction, a separate agency disclosure form should be used for each.

Dual Agency

When a broker is the agent for both the buyer and the seller in a transaction, he is acting as a dual agent. Whenever a broker acts as a dual agent, he should have written consent of all the parties to the transaction; the C.A.R. Agency Confirmation Statement (AC-6) (see Appendix, p. 166) satisfies this requirement if the purchase agreement used in the transaction does not contain a confirmation paragraph. The C.A.R. Purchase Agreement (C.A.R. Form RPA-CA) (see Appendix, page 166) contains a confirmation paragraph. The requirement for agreement of the principals to the dual agency is found in the Business and Professions Code Section §10176(d), as well as in case law, and is not limited to residential property; all real property transactions carry this requirement.

If a real estate licensee fails to disclose his or her dual agency to either principal, the following consequences may result:

• the unknowing or nonconsenting principal may have the right to cancel the transaction whether or not that principal incurred actual damages; • either principal can hold the licensee responsible for damages actually incurred; • either principal has the right to refuse to compensate the licensee; • the agent's real estate license may be suspended or revoked.

Agency Election and Confirmation

After the disclosure obligation has been satisfied, the agent then "elects" the type of agency that he or she will be following for that transaction. In other words, once a buyer decides to make an offer on the property, the agents know who will represent whom.

In a "" (FSBO) transaction, there may be various agency options. If the seller does not want to be represented by the agent who brought in the buyer, the agent may elect to be an exclusive buyer's agent. On the other hand, the agent may also elect to represent both parties as a dual agent.

Finally, the third step must be completed; the agent must "confirm" with the principals to the transaction the type of agency elected. This means putting in writing the agency election and thereby disclosing to the parties who will be representing whom in the transaction.

As with the Agency Disclosure Statement, the wording of the Agency Confirmation Statement is also dictated by law. Both brokers, as well as the buyers and sellers, may sign an Agency Confirmation Statement either on a separate form (C.A.R. Form AC-6) or on the C.A.R. Purchase Agreement, as long as the legislative language is used. The Agency Confirmation Statement confirms that the listing broker represents the seller exclusively or both the seller and the buyer, and that the selling broker represents the seller exclusively, the buyer exclusively, or both the buyer and the seller.

Timing of the Agency Confirmation Step

The timing of the Agency Confirmation Statement is also specified by law. The statement must be signed by all parties prior to or at the same time as the execution of the Purchase Agreement.

• The listing agent must confirm with the seller as early as practicable, but no later than the signing of the Purchase Agreement. The listing agent has no obligation to confirm with the buyer unless the listing agent is also the selling agent in the transaction. • The selling agent has the obligation to confirm agency with both the buyer and the seller as early as practicable, but no later than the signing of the Purchase Agreement.

Other Important Early Agent Disclosures

Negotiability of Commission

Real estate licensees are obligated to disclose to their principals that the amount of real estate commissions is negotiable, and are not set by law. Business and Professions Code Section §10147.5 requires that any standard form agreement initially establishing or altering a licensee's right to compensation on the sale of residential property improved with one-to-four dwelling units (or for the sale of a mobilehome) must contain the following statement:

Notice: The amount or rate of real estate commissions is not fixed by law. They are set by each broker individually and may be negotiable between the seller and broker.

All C.A.R. listing agreements (BRE, RLAA, RLA, MHL, BRNE, RLAN, PL, SP, VRL, and CLA) contain this mandatory statutory language.

Note: This statutory language is required only for standard form agreements. That means a personal letter or an individually drafted agreement between agent and principal specifying the commission to be paid for a particular transaction need not contain the statutory language.

Disclosure of Direct or Indirect Interest in Real Property

Also, California Business and Professional Code Section §10177(o) requires a licensee who is acting as an agent for the buyer to disclose to the buyer the existence of any direct or indirect ownership interest which the licensee may have in the property. The ownership interest by someone related to the licensee either by blood or marriage, or by someone with whom the licensee has a special relationship, or by an entity in which the licensee has an ownership interest, also requires disclosure to the buyer by the licensee. This disclosure should be in writing.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. A disclosure obligation can be mandated by: a. local government

b. state government

c. federal government

d. all of the above

2. Agency legislation requires licensees to comply with a three-step process. Which is not one of the steps? a. disclosure

b. election

c. verification

d. confirmation

3. A mandated disclosure is an item of information which is required by law to be conveyed from one entity involved in a real estate transaction to another. a. True

b. False

4. Agency disclosure may be made by the agent after the purchase agreement has been signed. a. True

b. False

5. If two salespeople work for the same broker, one can be the seller's exclusive agent and the other can be the buyer's exclusive agent in the same transaction. a. True

b. False

The Transfer Disclosure Statement

As you read, think about:

• The content of the Transfer Disclosure Statement • Who is responsible for the delivery of the Transfer Disclosure Statement • A separate duty from the TDS: the broker's obligation to conduct a reasonably competent and diligent visual inspection of the property for sale

Introduction

A Real Estate Transfer Disclosure Statement--covered in California Civil Code Sections 1102 through 1102.14--must be provided to the transferee by the transferor of residential real property improved with one-to-four dwelling units, as well as personal property mobilehomes and manufactured homes, identifying:

• whether specified items are contained in the residence or on the property, and whether such items are operational; • significant defects in certain structural components of the residence; and • other information regarding improvements and alterations as well as certain concerns with neighbors and the neighborhood.

Transfer means a sale, exchange, installment land sale contract, option, -option, any other option to purchase, or a ground lease coupled with improvements. Civil Code Section 1102.2 establishes ten categories of exemptions to the requirement that a transferor provide the Transfer Disclosure Statement. Some common exemptions are transfers ordered in probate, bankruptcy, by a sale, by a trust, from one co-owner to another, and between spouses. A list of all the exemptions is located on the back of C.A.R.'s Transfer Disclosure Statement (TDS). (See Appendix, p. 166, for a copy of the TDS and see p. 48 for the complete list of exemptions.)

Parties Responsible for Delivery of the TDS (MHTDS for Mobilehomes)

The party responsible for delivering the Transfer Disclosure Statement varies, depending upon how many licensees are involved in the transaction. If no licensees are involved in the sale, then the seller is responsible for delivery of the statement to the buyer. If only one licensee is involved, then that licensee is responsible. If two licensees are involved, then the licensee who obtained the offer (the selling agent) is responsible for delivery. If the licensee responsible for delivery of the disclosure is unable to obtain it, and he or she does not have written assurance from the transferee that the Transfer Disclosure Statement has been received, then the transferee should be advised in writing of his or her right to receive such a statement.

It is important to note that although any person failing to perform these duties under the statute is liable for damages actually incurred, the contract does not become invalid because of failure to perform these duties.

When the Transfer Disclosure Statement Should Be Delivered

The Transfer Disclosure Statement should be delivered as soon as practicable, and preferably before, an execution of an offer to purchase. If the statement is delivered after execution of the offer to purchase, then the transferee has the right to cancel the offer within a certain time period. The cancellation right lasts for three days if the statement is delivered in person and five days if delivery is made by mail. In order to exercise the cancellation right, a written notice of termination must be delivered by the transferee to the transferor or the transferor's agent.

Note: There is no cancellation right if the Transfer Disclosure Statement is given to a prospective buyer before the buyer makes his or her offer.

Note: For the sale or a "lease with an option to purchase" of a manufactured home or mobilehome involving an agent, the MHTDS must be delivered as soon as practicable, but no later than the close of escrow on the purchase portion of the transaction. When there is no agent involved in the transaction, the MHTDS must be given at the same time as when the Purchase Agreement is signed by the parties, if it has not been given in advance.

The Contents of the Transfer Disclosure Statement

The form and wording of the Transfer Disclosure Statement is prescribed by law and may not be modified; however, supplemental documents may be used to expand on the information given in the basic Transfer Disclosure Statement. (See Appendix, p. 166, for copies of the TDS and the MHTDS.)

There are four sections to the Transfer Disclosure Statement:

Section I Section I provides an area for a list of substituted disclosure forms. These property disclosures are discussed in a later section of this chapter.

Section II Section II is for the disclosures that are to be made by the seller, whether the seller occupies the property or not. This section is to be completed by the seller, and the disclosures in this section are specifically the disclosures of the seller and not of the agent. The agent should not complete this section for the seller.

Section III The first time an agent becomes involved in the preparation of this document is with Section III, and then only if the seller is represented by an agent in the transaction. The agent's duty to conduct a reasonably competent and diligent visual inspection of a property offered for sale is contained in Civil Code §2079 and is discussed below. The results of that inspection may be recorded in Section III of the Transfer Disclosure Statement by the listing agent. Section IV Section IV of the Transfer Disclosure Statement requires the record of the selling agent's competent and diligent visual inspection if the selling agent is a different broker (office) than the listing broker.

A 's Separate Duty: Reasonably Competent and Diligent Visual Inspection

Inspection of the property for sale is to be done by both the listing and selling agents even if the transaction is exempt from the requirement of a Transfer Disclosure Statement. When the seller is exempt from the Transfer Disclosure Statement law, the agent may use the C.A.R. form, Agent's Visual Inspection Disclosure (C.A.R. Form AVID) (see Appendix, p. 166). The agent's responsibility to conduct an inspection is independent from that of the seller to deliver a Transfer Disclosure Statement. The famous Easton v. Strassburger case formed the basis for a standard of conduct in California which licensees are obligated to follow, and was subsequently followed by Civil Code Sections 2079 through 2079.6, which set forth the agent's duty to inspect.

Civil Code Section 2079 requires a broker to conduct a "reasonably competent and diligent visual inspection" of a property offered for sale. Disclosure is required of all material facts resulting from the inspection that might affect the value or desirability of the property.

The statute does not require the licensee to inspect those areas that are normally and reasonably inaccessible. An agent is not required to inspect areas off the site of the property. In addition, the statute indicates that there is no affirmative duty to inspect public records or permits. The statute also does not require that the results be conveyed in writing; nevertheless, it is prudent to do so. The disclosure may be made in the "Agent's Inspection" part(s) of the Transfer Disclosure Statement, or on an Agent's Visual Inspection Disclosure form (C.A.R. Form AVID) in TDS exempt transactions.

Note of Warning: Although Civil Code Section 2079.3 limits an agent's duty of inspection as described in the previous paragraph, the courts have held that buyers' agents may have a greater duty under common law than required by these statutes. (Field v. Century 21 Klowden-Forness)

Section 2079--the "agent's duty to inspect" statute--applies to the sale of residential real property comprising one-to-four dwelling units, including manufactured homes and personal property mobilehomes. Unlike the law requiring the delivery of a Transfer Disclosure Statement, the only exemptions from this law are for certain sales of new subdivision property. More specifically, this law not only applies to sales transactions of residential real property comprising one-to-four units but also to leases with an option to purchase, ground leases of land on which one-to-four units have been constructed, or real property sales contracts (installment land sale contracts).

For additional information, the following legal memoranda are available on CAR Online at http://www.car.org: "Transfer Disclosure Statement Law" and "Real Estate Licensee's Duty to Inspect Residential Property." Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. Delivery of the Transfer Disclosure Statement is: a. optional

b. always required

c. required for residential one-to-four properties, unless exempt

d. is required for all residential properties unless exempt

2. The agent's inspection of the property for sale is to be done by both the listing and selling agents, unless the transaction is exempt from the requirement of a Transfer Disclosure Statement. a. True

b. False

3. If two licensees are involved in a transaction, the one who obtained the offer (the selling agent) is responsible for delivery of the Transfer Disclosure Statement to the buyer. a. True

b. False

Natural Hazard Disclosure Statement

As you read, think about:

• The various Natural Hazard Zone Disclosures which must be made by sellers and/or agents involved in the sale of certain real property • Why exemption from the Natural Hazard Disclosure Statement Law does not necessarily mean a seller is exempt from disclosing the fact that the property is located in a designated zone

Natural Hazard Zones and the Natural Hazard Disclosure Statement

In 1997, the California Legislature passed a bill which requires sellers and their agents to disclose to a prospective buyer that the property for sale is located in certain types of natural hazard zones and to make this disclosure on a statutory form known as the Natural Hazard Disclosure Statement (NHD). This law can be found in California Civil Code Sections 1103 through 1103.14. This law also permits the disclosure to be done on a local option real estate disclosure statement ("local option form") as an alternative. The law specifies that the NHD form or local option form must be provided to the buyer in all transactions where the seller is obligated to provide the buyer with a Transfer Disclosure Statement and where the property is located in at least one of the six natural hazard zones described on the NHD.

Important Note: Although a transaction may be exempt from the TDS Law and, thus, be exempt from the NHD Law (providing the NHD form), the seller may still be obligated to disclose to the buyer the fact that the property is located in a certain zone. The reason for this discrepancy is that certain zone disclosures were required by law before the NHD law passed and, thus, do not have the same exemptions.

Existing law, prior to the NHD, already required disclosure if the property was located in certain types of natural hazard zones (earthquake fault zones, seismic hazard zones and wildland fire areas). The new statutory form--the NHD--consolidates in one place six independent statutory disclosure requirements, three of which were existing disclosure statutes and three of which became law under the new legislation.

The six "zone" disclosures are as follows:

1. A flood hazard zone as designated by the Federal Emergency Management Agency ("FEMA"); 2. An area of potential flooding after a dam failure (also known as a "dam failure inundation area"); 3. A high fire hazard severity zone; 4. A wildland fire area (also known as "State fire responsibility area" or "SRA"); 5. An earthquake fault zone (formerly known as a "special studies zone"); and 6. A seismic hazard zone. (Civil Code §1102.6c.)

If the property is not located in any of the six zones, no NHD need be given to the buyer. If the property is located in at least one of these zones, then sellers and real estate licensees may use C.A.R. Form NHD (see Appendix, p. 166).

Furthermore, there are private disclosure companies that do the investigations and provide a report as well as their version of the statutory form. Neither the seller nor listing or selling agent will be liable for any error, inaccuracy, or omission of any zone disclosure information that was provided by a public agency or a licensed engineer, land surveyor, geologist, or expert in natural hazard discovery, dealing with matters within the scope of the professional's license or expertise.

1. Flood Hazard Zone Disclosure (Zone A and Zone V)

Certain areas have been designated by the federal government as special flood hazard zones. The Federal Emergency Management Agency (FEMA) creates Flood Hazard Boundary Maps identifying the flood hazard areas in Zone A and Zone V. The seller's agent, or the seller if there is no listing agent, has a duty to disclose to the buyer if the property is located in a flood hazard zone. This duty applies only if the local jurisdiction has compiled a list, by parcel, of properties within the zone, and a notice has been posted at the offices of the county recorder, county assessor, and county planning agency identifying the location of the parcel list; or if either the seller or seller's agent has actual knowledge that the property is located in a flood hazard zone.

2. Area of Potential Flooding

The area of potential flooding after a dam failure (also known as a dam failure inundation area) is an area of potential flooding in the event of a sudden or total failure of a dam.

The seller's agent, or the seller if there is no listing agent, has a duty to disclose to the buyer if the property is located in an area of potential flooding. Again, this duty applies only if the local jurisdiction has compiled a list, by parcel, of properties within the zone, and a notice has been posted at the offices of the county recorder, county assessor, and county planning agency identifying the location of the parcel list; or if either the seller or seller's agent has actual knowledge that the property is located in an area of potential flooding.

3. High Fire Hazard Severity Zone

When the property is located in a government-designated high fire hazard severity zone, the seller must disclose that the property is located within such an area.

Again, this duty applies only if the local jurisdiction has compiled a list, by parcel, of properties within the zone, and a notice has been posted at the offices of the county recorder, county assessor, and county planning agency identifying the location of the parcel list; or if either the seller or seller's agent has actual knowledge that the property is located in a high fire hazard severity zone.

4. Wildland Fire Area (also known as a State Fire Responsibility Area)

If real property is located in a designated State fire responsibility area (an area where the financial responsibility of preventing and suppressing fires primarily rests with the State of California, generally a "wildland area"), the seller must disclose this fact to the buyer. Disclosure to the buyer of the risk of fire, State-imposed additional duties such as maintaining fire breaks, and the fact that the State may not provide fire protection services must also be made in certain situations.

The California Department of Forestry creates maps of the State fire responsibility areas. Again, the duty of disclosure applies only if the local jurisdiction has compiled a list, by parcel, of properties within the zone, and a notice has been posted at the offices of the county recorder, county assessor, and county planning agency identifying the location of the parcel list; or if either the seller or seller's agent has actual knowledge that the property is located in a wildland fire area. This disclosure must be made even if the seller is exempt from providing the NHD statement (i.e., the seller is exempt from the TDS law).

5. Earthquake Fault Zones

Earthquake fault zones are areas designated by the State Geologist which may contain one or more potentially active earthquake faults that may be hazardous to structures due to "surface faulting" or "fault creep." The law which deals with these zones is the Alquist-Priolo Special Studies Zones Act.

The seller's agent, or the seller if there is no listing agent, has a duty to disclose to the buyer if the property is located in an earthquake fault zone. Again, this duty applies only if the local jurisdiction has compiled a list, by parcel, of properties within the zone, and a notice has been posted at the offices of the county recorder, county assessor, and county planning agency identifying the location of the parcel list; or if either the seller or seller's agent has actual knowledge that the property is located in an earthquake fault zone.

This disclosure must be made even if the seller is exempt from providing the NHD statement (i.e., the seller is exempt from the TDS law).

If property is located within an earthquake fault zone, the seller's agent (or the seller if the seller is acting without an agent) must disclose to any prospective purchaser the fact that the property is located within this zone, if maps identifying these areas are "reasonably available."

Additionally, even if a property may be exempt from disclosure under law, licensees should still disclose the fact that the property is located within this zone, as this fact may be considered a material fact which requires disclosure.

For additional information, see the legal memorandum, "Natural Hazard Disclosure Statement," which is available on CAR Online (see Appendix, p. 166).

6. Seismic Hazard Zones

Seismic hazard zones are areas subject to strong ground shaking, liquefaction, landslide, or other specific types of ground failure. The law which deals with these zones is the Seismic Hazards Mapping Act.

The seller's agent, or the seller if there is no listing agent, has a duty to disclose to the buyer if the property is located in a seismic hazard zone. Again, this duty applies only if the local jurisdiction has compiled a list, by parcel, of properties within the zone and a notice has been posted at the offices of the county recorder, county assessor, and county planning agency identifying the location of the parcel list; or if either the seller or seller's agent has actual knowledge that the property is located in a seismic hazard zone.

This disclosure must be made even if the seller is exempt from providing the NHD statement (i.e., the seller is exempt from the TDS law). If property is located within a seismic hazard zone, the seller's agent (or the seller if the seller is acting without an agent) must disclose to any prospective purchaser the fact that the property is located within this zone, if maps identifying these areas are "reasonably available" and not subject to an exemption.

Additionally, even if a property may be exempt from disclosure under this law, licensees should still disclose the fact that the property is located within this zone, as this fact may be considered a material fact which requires disclosure.

For additional information, see the legal memorandum, "Natural Hazard Disclosure Statement," which is available on CAR Online (see Appendix, p. 166).

For a quick guide on the required zone disclosures or the exemptions from the duty to provide the NHD form, see the legal memoranda, "Summary Disclosure Chart for REALTORS®" and "Sales Disclosure Chart for REALTORS®."

Limitation on Liability for Errors or Nondisclosure

Under the Natural Hazard Zone Disclosure Law, neither the seller nor either real estate agent is liable for any error, inaccuracy, or omission of any information on the NHD form, provided that the accurate information was not within the personal knowledge of the seller or agent and the information provided was based on information from a third-party disclosure company.

Finally, the purchase contract cannot be invalidated as a result of failure to comply with the disclosure requirements under the Natural Hazard Zone Disclosure Law. However, the seller or agent who willfully or negligently violates or fails to perform any duty under this law can be held liable in the amount of actual damages incurred by the buyer.

Other Property Disclosures

As you read, think about:

• The various disclosures, other than natural hazard zone disclosures, which must be made by sellers and/or agents involved in the sale of real property

1915 Bond Act Assessments

On January 1, 2002, legislation took effect requiring most sellers of residential one- to-four unit properties to request from local agencies, and then disclose to buyers, information regarding assessments levied under the Improvement Bond Act of 1915, a method of financing certain public improvements. Unfortunately, local governments have been slow to respond to this legislation, and generally cannot provide the required assessment notices, making it difficult for sellers to fully comply with this new law.

In response, C.A.R. introduced legislation (Senate Bill 1879) creating other methods for complying with this disclosure requirement. A seller may provide a buyer with an official assessment notice provided by the appropriate local agency (if available), but may also provide a substantially equivalent notice obtained from a non-governmental source.

On January 1, 2003, additional legislation (Assembly Bill 337) was passed which provides guidance to non-governmental sources (e.g., disclosure companies) so that they may provide valid substituted notices for both 1915 Bond Act assessments and Mello-Roos taxes. This legislation allows sellers to comply with these important disclosure laws, whether or not local governments provide the necessary notices.

This law provides the same exemptions as for the Transfer Disclosure Statement except that new subdivisions are not exempt.

There is no affirmative duty by a real estate licensee to discover a special tax or district or assessment not actually known to the agent. However, sellers must make a good faith effort to obtain this information.

Condominiums/Planned Developments: Additional Disclosures

According to Civil Code Section 1368, the seller of a separate interest in a common interest development (such as a or a home in a planned development) is required to provide the buyer with certain information about the planned development as soon as practicable before the transfer of title.

The required items are:

• a copy of the governing documents of the common interest development, such as the CC&R's and the association's Articles of Incorporation; • if there are any age restrictions in the governing documents, a statement that they are only enforceable to the extent permitted by Civil Code §51.3, and a statement specifying the applicable provisions of Civil Code §51.3. This statement should be in writing. (Civil Code §51.3 concerns the establishment and preservation of housing for senior citizens); • a copy of the most recent financial statements prepared by the association, including an assessment and reserve funding disclosure; • a written statement from an authorized representative of the association concerning regular and special assessment amounts, and concerning late charges, the unit owner's assessments, monetary fines and penalties still unpaid, interest and costs of collections, which, as of the date of the statement, are or may be a lien on the owner's interest; • a copy or summary of any notices sent to the unit owner regarding any violations of the CC&R's or regulations that remain unresolved; • a copy of the preliminary list of defects provided to each owner regarding any construction defect dispute with the builder pursuant to Section 1375 (unless the matter has been resolved by a settlement agreement or otherwise); • a copy of the latest information regarding dispute resolution with the builder pursuant to Section 1375.1; and • any change in the association's current regular and special assessments and fees which have been approved by the Board of Directors but have not yet become due and payable. Additional information, such as copies of the minutes of meetings, may be required by contract between the buyer and the seller. C.A.R. Form RPA-CA, the California Residential Purchase Agreement and Joint Escrow Instructions, requires 12 months of homeowners' association minutes of meetings, among other information.

C.A.R. Form HOA, Homeowner Association Information Request, (see Appendix, p. 166) is available to assist the seller in requesting the necessary information from the homeowners' association.

For additional information, refer to the legal memoranda, "Condominium or Other Common Interest Development Disclosures" and also for new developments, "New Home (Residential One-to-Four Units) Disclosure Chart" which are available on CAR Online.

Death and AIDS

Under Civil Code Section 1710.2, neither a seller nor a licensee must disclose any death, nor the manner of death, on the property, if the death occurred more than three years prior to the date the buyer offers to purchase, lease, or rent the property.

Any death which has occurred within the last three years should be disclosed if deemed to be "material." What constitutes a "material" death is normally decided by the courts. The courts have already determined that a death by murder is material. It is unclear whether a death by suicide or natural causes is material or not. Thus, it is probably wise to disclose such deaths if they have occurred within the three-year period discussed above.

Affliction with AIDS or death from AIDS, however, no matter when it occurred, need not be voluntarily disclosed. If the seller or licensee is asked directly about death from AIDS upon a property or whether the seller has AIDS, he or she cannot intentionally misrepresent the facts. It may be prudent for an agent in this situation to state that he or she is not authorized to discuss the topic.

For additional information on this law, refer to the legal memorandum, "Disclosure of DEATH and AIDS and the Prohibition Against Discrimination on the Basis of AIDS," (see Appendix, p. 166) which is available on CAR Online.

Methamphetamine Contamination Notice

Sellers of residential property of one-to-four units (and of all residential rental property) must disclose to buyers (or tenants) information about a former drug lab on the premises. This disclosure requirement has the same exemptions as the TDS; however, if a seller has actual knowledge, this information would most likely fall under the category of being a "material fact" that must be disclosed to a buyer (or tenant).

In the event that toxic contamination by an illegal controlled substance has occurred on a property and upon receipt of a notice from the Department of Toxic Substances Control (DTSC) or other agency--or if the seller has actual knowledge of the toxic contamination--the seller must disclose this information to the buyer by checking Item II.C.1 of the TDS form and attaching the DTSC notice, if there is one.

In the case of rental property, the must give a prospective tenant written notice of the toxic contamination. Providing the tenant with a copy of the DTSC notice will suffice, if there is such a notice.

Earthquake Safety: Homeowner's Guide

The seller of one-to-four residential units of conventional light-frame construction, built prior to January 1, 1960, must deliver to the buyer a booklet titled "The Homeowner's Guide to Earthquake Safety," unless an exemption applies. The booklet, which was developed by the California Seismic Safety Commission, describes seismic hazards and provides information on how to prevent and repair earthquake damage.

A seller must deliver the Homeowner's Guide to a buyer if the property meets the conditions stated above. The real estate licensee is required to provide the seller with a copy of the Homeowner's Guide for delivery to a buyer, and the seller must give this booklet to the buyer. In general, the exemptions are the same as for the Transfer Disclosure Statement. An additional exemption applies if the buyer agrees in writing that the dwelling will be demolished within one year of the date of transfer.

Although delivery of the booklet is not always mandatory, it is a good idea for sellers to voluntarily give the booklet to buyers. If a seller or broker delivers the Homeowner's Guide to a prospective purchaser, the seller or broker is not required to provide additional information concerning general geologic or seismic hazards or mitigating measures that the buyer or seller might consider. Of course, the location of a property within Earthquake Fault or Seismic Hazard Zones and the existence of known hazards or deficiencies on or affecting the real property for sale must still be disclosed as otherwise required, regardless of whether a booklet is delivered or not. The seller also must make certain other earthquake-related disclosures specified by law.

Earthquake Safety: Commercial Property Owner's Guide

The law also mandates delivery of "The Commercial Property Owner's Guide to Earthquake Safety," by a seller or his or her agent to a buyer if the property meets specific conditions. The conditions for delivery are as follows: any real property built of pre-cast concrete or reinforced/unreinforced masonry building with wood frame floors or roofs built before January 1, 1975, located within a city or county, if no exemption applies. (Exemptions are the same as for the Homeowner's Guide.) In addition, any property built of unreinforced masonry with nonload bearing walls of steel or concrete frames is also exempt.

The seller or seller's agent must give the buyer a copy of the booklet if the property meets the above conditions. If the delivery of the booklet is not mandatory, but is voluntarily delivered to the buyer, then the seller or his agent is not required to provide additional information concerning general earthquake hazards. Of course, known earthquake hazards must be disclosed whether delivery is mandatory or voluntary. Environmental Hazards Booklet

The seller must disclose any known information regarding environmental hazards on the property, which is no different than disclosing any other material fact.

Pursuant to Business and Professions Code §10084.1, the Department of Real Estate (with the assistance of the State Department of Health Services), has developed a consumer education booklet concerning common environmental hazards. The booklet is used for the purpose of educating and informing consumers on common environmental hazards that are located on, and affect, real property.

If the "Environmental Hazards Booklet" is delivered to a buyer, then the seller and broker are not required to provide additional information to the buyer concerning common environmental hazards, described in the booklet, that can affect real property. Of course, if the seller or broker has actual knowledge of the existence of environmental hazards on or affecting the property, then those items must be disclosed.

Note: The law does not require that the seller or agents provide this booklet to the buyer. However, it is highly recommended that this booklet be given to the buyer.

FHA Loans/HUD Sales

When the transaction involves residential real property of one-to-four units (including a mobilehome on a permanent foundation) and the borrower will be obtaining an FHA loan that will require FHA (also for sales of HUD- owned properties), a special form is required to be given to the buyer/borrower. The borrower must receive the notice, The Importance of a Home Inspection, (Notice) and sign it before execution of the purchase contract. C.A.R. Form HID (see Appendix, p. 166) may be used for this purpose.

For mortgages insured under FHA's Home Equity Conversion Mortgage program, the Notice is not required if the borrower has certified that a child under the age of six will not be residing in the property. New construction is exempt since the was recently inspected during construction. Also, refinance transactions are exempt.

The Notice simply provides a disclosure to the purchaser that:

• FHA does not warrant the value or condition of the property; • an appraisal is not a home inspection; • the borrower has the right to have the house inspected by a professional home inspector.

Whether or not to inspect the property is a matter of contract between a seller and buyer. The C.A.R. Residential Purchase Agreement (RPA-CA) permits a buyer to obtain a property inspection within an agreed-upon period of time. Up to $200 of the cost of the inspection may be financed through the loan. For additional information on this law, refer to the legal memorandum, "FHA Inspection Disclosure Form," (see Appendix, p. 166) which is available on CAR Online.

On all HUD-owned property, the buyer must be provided with a notice that HUD is making no representations regarding the presence of radon gas or mold on the property. In addition, the buyer releases HUD from liability in connection with the radon or mold. C.A.R Form Radon Gas and Mold Notice and Release Agreement (RGM) may be used for this purpose.

FIRPTA and California Withholding: Affidavit of Non-Foreign Status and/or California Residency

Federal Requirements

The Foreign Investment in Real Act (FIRPTA) imposes upon a buyer of real property an obligation to withhold 10% of the sales price of a U.S. real property interest if the seller is a foreign person, and to send that sum to the IRS, unless an exemption applies. Failure to withhold the 10% may subject the buyer to a penalty equal to the full 10% that should have been withheld, or the seller's actual tax liability in the sale, whichever is less, plus interest and other penalties. This may occur if the buyer fails to obtain from the seller an Affidavit of Non-Foreign Status and the seller fails to pay taxes due on the sale.

There are several exemptions to the buyer's withholding obligation. One exemption is if the seller is not a foreign person. Without documentation, the buyer cannot know if the seller is a foreign person. Therefore, if the seller is not a foreign person, he or she should provide the buyer with an Affidavit of Non- Foreign Status, in which the seller provides a U.S. taxpayer identification number and states under penalty of perjury that he is not a foreign person. C.A.R. Form AS (see Appendix, p. 166) may be used for this purpose.

Note: This exemption does not apply if the buyer has actual knowledge that the affidavit is false.

A second exemption to the buyer's requirement to withhold the tax is if the property sells for less than $300,000 and the buyer intends to occupy the property as his residence. The buyer must intend to occupy the property for 50% of the time during the first two years after the transfer for the property to qualify as a residence. In the situation in which the seller is a foreign person but wants to claim this exemption so that the 10% need not be withhold during escrow, the buyer should execute a Buyer's Affidavit. C.A.R. Form AB (see Appendix, p. 166) may be used for this purpose.

For additional information on this law, refer to the legal memorandum, "Federal Withholding: The Foreign Investment in Real Property Tax Act (FIRPTA)," (see Appendix, p. 166) which is available on CAR Online.

California Requirements The State of California requires the buyer of a California real property to withhold 3 1/3% of the gross sales price of the property when the buyer is a "natural" person (as opposed to a corporation) regardless of whether the seller is a California resident or not, unless an exemption applies.

If the seller is a corporation, the buyer must withhold if the seller has no permanent place of business in California or is not qualified to do business in California.

The exemptions if the seller is a "natural" person are as follows:

• The property sells for $100,000 or less. • The property is the seller's "principal place of residence" as defined in the Internal Revenue Code Section (IRC) 121 or was last used as such without regard to the two-year period. • The property is part of an IRC §1031 exchange (but only to the extent of the amount of gain not required to be recognized for California income tax purposes under IRC §1031). • The property has been involuntarily or compulsorily converted (i.e., a "taking"), and the seller intends to acquire property similar or related in service or use in order to be eligible for nonrecognition of gain for California income tax purposes under IRC §1033. • The seller signs an affidavit under penalty of perjury stating that the transaction will result in a loss for California income tax purposes. • The buyer does not receive written notification of the withholding requirement from the "real estate escrow person." [Note: This places a notification burden upon the escrow agent.] • The property is acquired by a corporate beneficiary under a of trust or mortgage through judicial or nonjudicial foreclosure or by a deed in lieu of foreclosure. • Seller's tax liability, calculated at the maximum rate, regardless of seller's actual rate, will be less than the 3 1/3% withholdings otherwise required.

Again, C.A.R. Form AS may be used to comply with this law.

For additional information on this law, refer to the legal memorandum, "California Withholding on the Sale of Real Property," (see Appendix, p. 166) which is available on CAR Online.

Flood Disaster Insurance

When transferring a mobilehome or any residential or commercial property where the owner has received federal flood disaster assistance--after September 23, 1994-- conditioned on the owner subsequently obtaining and maintaining , the seller must disclose this information in writing "on a document evidencing title" to a buyer. Failure to notify the buyer means that in the event the buyer fails to maintain the required flood insurance and the property is damaged by a flood disaster requiring federal disaster relief, the seller will be required to reimburse the federal government.

"Transfer" for the purposes of this law means transfer by sale, lease with option to purchase, purchase option, ground lease coupled with improvements, installment land sale contract, or transfer of a residential stock cooperative.

For additional information on this law, refer to the legal memorandum, "Federal Flood Insurance Disclosure," (see Appendix, p. 166) which is available on CAR Online.

Industrial Use Zones

The seller or transferor of residential real property of one-to-four units, subject to the TDS law, must disclose "actual knowledge" that the property is adjacent to or zoned to allow, an industrial use of property (manufacturing, commercial, or airport use), or affected by a nuisance created by such use, as soon as possible before transfer of title.

"Transfer" for the purposes of this law means transfer by sale, lease with option to purchase, purchase option, ground lease coupled with improvements, installment land sale contract, or transfer of a residential stock cooperative.

Lead-Based Paint Hazards Disclosures

Lead is highly toxic to infants and small children who may inhale or ingest it. Interior and exterior paints in homes built prior to 1949 are almost certain to have a high lead content, and paints manufactured up to the mid-1970's may contain toxic levels of lead.

Federal law requires the seller (and ) to provide the buyer (and lessee) with a lead hazard information pamphlet to disclose the presence of any known lead-based paint. The seller (and lessor) is also required to provide a statement signed by the buyer that the buyer has read the warning statement and has received the pamphlet before being obligated under the applicable contract.

The buyer (but not a lessee) is permitted a 10-day period to conduct an inspection unless the parties mutually agree upon a different time period.

This law applies to the sale or lease of all residential property, built before 1978, except as indicated below. Mobilehomes are also subject to this law.

The exemptions are as follows:

• foreclosure or trustee's sale transfer (REO properties and deed in lieu of are NOT exempt!) • zero-bedroom dwelling (loft, efficiency unit, dorm, or studio) • short-term rental (100 or fewer days) • housing for elderly or handicapped (unless children live there) • rental housing certified free of lead paint

C.A.R. Form FLD (see Appendix, p. 166) may be used. In addition, the pamphlet entitled "Protect Your Family from Lead in Your Home" or an equivalent approved pamphlet must be given to the buyer. For additional information on this law, refer to the legal memorandum, "Federal Lead-Based Paint Hazards Disclosure," (see Appendix, p. 166) which is available on CAR Online.

Material Facts Disclosure

For many properties, there are outside factors or property defects that can be construed as material facts affecting the value or desirability of the property. The sellers and the agents, if they have actual knowledge of such factors, should disclose these items to a potential buyer of the property. Outside factors include, but are not necessarily limited to: neighborhood noise, problems, or other nuisances; violations; and the existence of CC&R's or a homeowners' association.

Megan's Law

Megan's Law--a California statute--applies to the sale, lease, or rental of all residential real property of one-to-four units. The only exemptions are for never- occupied properties where a public report is required or properties exempted from a public report pursuant to Business & Professions Code Section 11010.4 (e.g., new subdivisions located entirely within a city in which there are no common areas). This law also applies to leases with an option to purchase, ground leases of land improved with one-to-four residential units, and real property installment sales contracts.

Every lease or rental agreement and every sales contract is required to include a statutorily-defined notice regarding the existence of public access to a database containing information regarding sex offenders. The following C.A.R. forms contain this statutory notice: LR, MHPA, NODPA, PPA, RIPA, RPA-CA.

A real estate licensee has no affirmative duty to investigate these databases; however, if the licensee has actual knowledge (not just speculation) that a sex offender resides in the area, that knowledge is very likely a material fact that must be disclosed.

For additional information on this law, refer to the legal memorandum, "Megan's Law: Notifying the Public About Registered Sex Offenders," (see Appendix, p. 166) which is available on CAR Online.

Mello-Roos Districts

Civil Code Section 1102.6b requires the disclosure of special Mello-Roos taxes and tax districts by the seller to the buyer. The seller is required to disclose to a prospective purchaser the existence of Mello-Roos taxes if the property is in a Mello-Roos District.

This law applies to the transfer or exchange of residential real property of one-to- four units subject to a continuing lien securing the levy of special taxes pursuant to the Mello-Roos Community Facilities Act.

The levying agency must assist sellers in disclosing the necessary information by designating an office, department, or bureau of the local agency to provide a document entitled Notice of Special Tax (Notice). This Notice is to be provided within five working days to any person requesting it or to any owner of property subject to a special tax. The seller must make a good faith effort to obtain the Notice from the local tax-levying agency and deliver the Notice to the prospective buyer. After receiving the Notice, the buyer has the right to terminate the transaction. The right lasts for three days if the Notice is delivered personally or five days if the Notice is delivered by mail.

While the law imposes no duty on an agent to discover a special tax or district not actually known to the agent, it may be prudent for agents to find out whether Mello- Roos Districts exist in their area in order to assist clients in meeting their disclosure obligations.

Note: Sellers may comply with this law by using a third-party disclosure company.

This law has the same exemptions as for the Transfer Disclosure Statement except that new subdivisions are not exempt.

For additional information on this law, refer to the legal memorandum, "Mello-Roos District Disclosure Requirements," (see Appendix, p. 166) which is available on CAR Online.

Military Ordnance Site

If a seller has actual knowledge of a former federal or state ordnance location within one mile of the subject property, this fact must be disclosed to the buyer. An ordnance location is an area once used for military training purposes which may contain potentially explosive munitions. This disclosure can be made on the Transfer Disclosure Statement.

Mold

There are no current specific disclosure or discovery requirements until at least six months after the Department of Health Services (DHS) develops permissible exposure limits for molds and develops a consumer booklet. After the DHS develops its guidelines, the law will apply to any sale, lease, rental, or other transfer of any commercial, industrial or residential property.

However, if the seller or real estate licensee now has actual knowledge of mold on the property, that information would most likely constitute a "material fact" requiring disclosure. Furthermore, obvious evidence of mold on the property may be deemed a "red flag" for a real estate licensee and should be part of the agent's duty to inspect disclosure.

The TDS has been modified to include the word "mold" in paragraph II.C.1.

For additional information on this law, refer to the legal memorandum, "Mold and Its Impact on Real Estate Transactions," (see Appendix, p. 166) which is available on CAR Online.

Smoke Detectors By California law, all existing dwelling units must have a smoke detector centrally located outside each sleeping area (a bedroom or group of bedrooms). Furthermore, for any new construction or any additions, alterations, repairs after August 14, 1992, that exceeds $1,000 in cost and for which a permit is required, or when a new bedroom is added, a smoke detector must be installed in each bedroom in addition to being centrally located in the corridor or area outside the bedroom.

For new construction only, the smoke detector must be hardwired with a battery backup. For all other homes, the smoke detector may be battery operated.

The seller of a single-family home or factory-built home must provide the buyer with a written statement indicating that the property is in compliance with current California law. C.A.R. Form WHSD (see Appendix, p. 166) may be used for this disclosure. All other types of "dwelling" units (e.g., condominium, stock cooperative, time-share project, duplex, or multi-unit complex) simply need to comply with the law, but the written statement of compliance need not be given to the buyer.

The exemptions from providing the written statement are the same as the TDS exemptions. However, transfers to or from any governmental entity, and transfers by a beneficiary or mortgagee after foreclosure sale or trustee's sale, or transfers by deed in lieu of foreclosure (which are exempt under the TDS law), are NOT exempt from this law.

Note: Local laws may have additional and more stringent smoke detector requirements. Therefore, it is advisable that real estate licensees contact the local Department of Building and Safety for additional information. Furthermore, many local governments have retrofit requirements.

For additional information on this law, refer to the legal memorandum, "Smoke Detector Requirements," (see Appendix, p. 166) which is available on CAR Online.

Structural Pest Control Reports

A seller is not required to provide a buyer with either a Structural Pest Control Report or Certification just because a property is transferred. However, if a report or certification is required pursuant to either the terms of the purchase contract or the buyer's financing arrangement, then the report and/or certification must be delivered.

The delivery of the documents should be made as soon as is practical prior to the transfer of title. Delivery may be made in person or by mail to either the transferee or an authorized representative of the transferee. Department of Real Estate Regulation 2905 imposes the obligation of delivery on the buyer's agent when there is more than one agent involved. If no agents are involved, then the seller must deliver the appropriate documents. If one agent is involved, that agent bears the responsibility of delivery. The Purchase Agreement can be used to require that a Structural Pest Control Report and/or Certification be made and delivered. Water Heater Bracing, Anchoring or Strapping Requirement

All owners of properties with water heaters must brace, anchor or strap the water heaters to resist falling or horizontal displacement due to earthquake motion. A "water heater" is defined as any standard water heater with a capacity of no more than 120 gallons for which a pre-engineered strapping kit is readily available.

The seller of real property must certify in writing to a buyer that he or she has complied with the applicable local code requirements. C.A.R. Form WHSD (see Appendix, p. 166) may be used for this disclosure. There are no specific exemptions from this law.

For additional information on this law, refer to the legal memorandum, "Water Heater Bracing and Disclosure Requirements," (see Appendix, p. 166) which is available on CAR Online.

Special Exemptions from Disclosure

Sometimes, despite the fact that something would be deemed a material fact, the law provides a special "out" from the sellers' or licensees' duty to disclose. The disclosure of AIDS or death by AIDS, discussed previously, is one such example.

Another example is the existence in the neighborhood of a childcare center or certain other residential care facilities. There is a lengthy C.A.R. legal memorandum available on CAR Online that details all the disclosure responsibilities (and exemptions) of residential care facilities: "Disclosure Issues Related to Residential Care Facilities and Day Care Homes."

Disclosure with respect to one special type of residential care facility, a domestic violence shelter, was addressed in a California attorney general's opinion. Basically, there is no duty to disclose the existence of a domestic violence shelter.

For additional information, see the C.A.R. legal memorandum, "Disclosure of the Existence of a Domestic Violence Shelter" (see Appendix, p. 166).

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. According to FIRPTA, who is responsible for withholding 10% of the purchase price of a property if the seller is a foreign person? a. the buyer

b. the seller

c. the buyer's agent

d. the seller's agent

2. Which of the following disclosures would not be made on a Natural Hazard Disclosure form? a. property located in an Earthquake Fault Zone

b. property located in a State Fire Responsibility Area

c. property within one mile of an ordnance

d. all of the above

3. A licensee need not disclose a death which occurred on a property five years prior to the date the buyer offered to purchase the property. a. True

b. False

Financing Disclosures

As you read, think about:

• The financing disclosures of which real estate licensees must be aware

There are a variety of financial disclosures required in the area of residential property sales or transfers. Among the most noteworthy for real estate licensees are the Seller Financing and the Mortgage Loan Disclosure Statements. (Laws related to real estate financing are covered in more depth in the next chapter.)

Seller Financing Disclosure Statement

Many residential sales involve the seller providing the buyer with financing for some or all of the purchase price. California Civil Code Sections 2956 through 2967 cover the law on this topic. The law requires that both the buyer and seller be provided with a statement disclosing information regarding the financing when the transaction involves the purchase of a residential one-to-four unit dwelling. The Seller Financing Addendum and Disclosure--C.A.R. Form SFA (see Appendix, p. 166)--may be used for this disclosure.

This disclosure form is not required if the buyer/borrower will be receiving one of the other mortgage loan disclosure forms under California law, or under federal law, such as the Truth-in-Lending Act or the Real Estate Settlement Procedures Act.

The person responsible for preparation of the statement is called the "arranger of credit." If there are two offices involved in the transaction, the selling agent is responsible for providing this disclosure. The information contained in the disclosure covers such topics as credit documents, credit terms, deferred interest, balloon payments, buyer creditworthiness, recording of documents, insurance, and requests for notices in event of default. Mortgage Loan Disclosure Statement

If a real estate licensee is arranging financing for additional compensation (not just the commission on the sale of the property), or is making a loan with his own money, secured by a lien on real property, he or she must provide the borrower with a Mortgage Loan Disclosure Statement within three days after receiving the loan application from the borrower.

The Mortgage Loan Disclosure Statement details the total costs of a loan to the borrower. It includes data regarding interest rates, balloon payments, security documents, costs, commission, etc. All items are to be completed by the broker, who must sign the disclosure and include his real estate license number before the borrower signs the document. The Mortgage Loan Disclosure Statement must be delivered to the borrower before the borrower becomes obligated to complete the loan. C.A.R. Form MS (see Appendix, p. 166) may be used for this purpose.

Brokers who make loans to borrowers from their own funds are required to provide all the appropriate documentation that is required of other lenders, including the Truth in Lending (Regulation Z) disclosures. These disclosures are in addition to the Mortgage Loan Disclosure Statement.

Summary

In this chapter, you have read about mandatory disclosures and why they must be made. You have studied the three-step process (disclosure, election, and confirmation) of complying with agency law. You learned about the Transfer Disclosure Statement and what is required for compliance with the law. You have learned that the broker's obligation to conduct a reasonably competent and diligent visual inspection of the property for sale is a separate obligation from that of the seller to complete the Transfer Disclosure Statement.

You have also learned about all the zone disclosures, as well as all the other disclosures required when dealing with the sale (or even lease) of residential one-to- four properties. In addition, you have learned about some of the special exemptions from disclosures, as well as about two financing disclosure forms.

By being aware of all the mandatory disclosure obligations placed on sellers and real estate agents, you will be better able to serve your clients, as well as reduce your risk in your business as a real estate licensee.

Disclosure laws are continuously changing. Therefore, it is paramount to keep abreast of all the new laws--both case law and statutes affecting disclosure obligations. The best way to stay informed is to visit the Legal Section of CAR Online on a regular basis. Look for the "What's New" and "New Law" topics found under "Real Estate Law" in the Legal section of CAR Online.

Appendix

Commonly Asked Questions About Disclosure

1. Q: What is the effect of noncompliance with the zone disclosure laws? A: Failure to disclose the existence of property in any of the six natural hazard zones does not invalidate the transfer. However, any seller or licensee who willfully or negligently fails to disclose, when required, is liable for the amount of actual damages suffered by the buyer. 2. Q: Must known geologic hazards on or affecting the real property be disclosed by a seller or licensee if a "Homeowner's Guide to Earthquake Safety" is delivered to the buyer? A: Yes. The location of property within an earthquake hazards zone or seismic

hazards zone or any of the six special zones must still be disclosed. 3. Q: How can I find out if a property is located within a flood hazard area? A: A Flood Hazard Boundary Map or a Flood Insurance Rate Map which sets forth flood hazard areas may be obtained from the Federal Emergency Management Agency (FEMA). Private disclosure companies will also provide this information. Furthermore, this information may also be posted at the local county assessor's office, county planning agency, and county recorder's office. 4. Q: Does a real estate licensee have a duty to inspect for the presence of environmental hazards on residential property? A: There is a legal requirement to disclose all known material facts; real estate licensees must also conduct a reasonably competent, diligent visual inspection of the accessible areas of the property offered for sale. The licensee must then disclose to the buyer all facts materially affecting the value or desirability of the property that the investigation revealed. Therefore, even if a licensee did not know of the presence of an environmental hazard in or on the residential property, if an inspection would reveal material "red flags" of any defect, the "red flags" should be disclosed to the buyer. The "red flag" is not the problem itself, but is an indicator of an underlying problem, whether an environmental hazard or other defect.

The application of these liability standards is the same for environmental hazards as for any other physical defect that exists on the property. However, the level of expertise required to identify even the "red flags" of a latent environmental hazard, much less the hazard itself, is often beyond that of the real estate licensee. Real estate licensees are not environmental experts; therefore, they cannot be expected to discover the subtle "red flag" indicators that an environmental expert would. A real estate licensee, however, should be alert for obvious "red flag" indicators, such as noxious fumes, abandoned leaking oil drums, or gasoline pumps. In order to avoid potential problems, a real estate licensee may wish to make the seller or buyer aware of the availability of an inspection for environmental hazards by an environmental expert. 5. Q: Can licensees fulfill their obligation to disclose material facts without utilizing the Transfer Disclosure Statement? A: Yes. Some brokerages may wish licensees to use company stationery, personal letterhead or Agent's Visual Inspection Disclosure form (C.A.R. Form AVID), and others may wish to create their own form for such a purpose. Indeed, when a seller is exempt from providing the TDS (such as in a probate sale or where the seller is a trust or has acquired the property through a foreclosure as the lender), the licensee must still inspect and disclose material facts, even though the TDS will not be provided by the seller. Exemptions from TDS Law

Cal Civ Code §1102.2 (2007)

§1102.2. Transactions to which article does not apply

This article does not apply to the following:

(a) Transfers which are required to be preceded by the furnishing to a prospective transferee of a copy of a public report pursuant to Section 11018.1 of the Business and Professions Code and transfers which can be made without a public report pursuant to Section 11010.4 of the Business and Professions Code.

(b) Transfers pursuant to court order, including, but not limited to, transfers ordered by a probate court in the administration of an estate, transfers pursuant to a writ of execution, transfers by any foreclosure sale, transfers by a trustee in bankruptcy, transfers by , and transfers resulting from a decree for specific performance.

(c) Transfers to a mortgagee by a mortgagor or successor in interest who is in default, transfers to a beneficiary of a deed of trust by a trustor or successor in interest who is in default, transfers by any foreclosure sale after default, transfers by any foreclosure sale after default in an obligation secured by a mortgage, transfers by a sale under a power of sale or any foreclosure sale under a decree of foreclosure after default in an obligation secured by a deed of trust or secured by any other instrument containing a power of sale, transfers by a mortgagee or a beneficiary under a deed of trust who has acquired the real property at a sale conducted pursuant to a power of sale under a mortgage or deed of trust or a sale pursuant to a decree of foreclosure or has acquired the real property by a deed in lieu of foreclosure, transfers to the legal owner or lienholder of a manufactured home or mobilehome by a registered owner or successor in interest who is in default, or transfers by reason of any foreclosure of a security interest in a manufactured home or mobilehome.

(d) Transfers by a fiduciary in the course of the administration of a decedent's estate, guardianship, conservatorship, or trust. This exemption shall not apply to a transfer if the trustee is a natural person who is sole trustee of a revocable trust and he or she is a former owner of the property or an occupant in possession of the property within the preceding year.

(e) Transfers from one co-owner to one or more other co-owners.

(f) Transfers made to a spouse, or to a person or persons in the lineal line of consanguinity of one or more of the transferors.

(g) Transfers between spouses resulting from a judgment of dissolution of marriage or of legal separation or from a property settlement agreement incidental to that judgment.

(h) Transfers by the Controller in the course of administering Chapter 7 (commencing with Section 1500) of Title 10 of Part 3 of the Code of Civil Procedure. (i) Transfers under Chapter 7 (commencing with Section 3691) or Chapter 8 (commencing with Section 3771) of Part 6 of Division 1 of the Revenue and Taxation Code.

(j) Transfers or exchanges to or from any governmental entity.

Financing Residential Real Estate

Introduction

Real estate agents seldom work with buyers making "all cash" purchases of property. In most real estate transactions, some form of financing is necessary to make the purchase. Therefore, a thorough understanding by licensees of the various financing options available is vital. To provide better service to your clients, and thereby increase your productivity, you must be both knowledgeable and creative in financing. You are in a position to help home buyers obtain financing, and with the many financing options available today, your buyers are bound to have questions. What is the difference between an adjustable rate loan and one with a fixed rate? What kind of special financing is available for veterans? Is leasing with the option to buy the same as a lease purchase agreement? By being able to explain financing options, you will be a valuable resource for both your buyers and sellers. The likelihood of your transactions collapsing in escrow will decrease, while the number of referrals from satisfied clients and customers will increase.

Objectives

After studying this chapter, you will be able to:

• Pre-qualify buyers for financing • Explain conventional financing options to your buyers • Identify financing programs provided by government agencies • Explain to sellers how to make a purchase more affordable for buyers who have difficulty coming up with a down payment and closing costs • Avoid disciplinary action by being aware of financing regulations and legislation

Key Terms/Concepts

The following are the key terms and concepts found in this chapter:

• Debt ratio • Buy-downs • Loan-to-value ratio • Shared equity • Conventional mortgage • RESPA • Private mortgage insurance • Non-conventional mortgage • Fixed rate mortgage • FHA Mortgage Insurance Program • Adjustable rate mortgage • Mortgage insurance program • Interest rate caps • VA Guaranteed Mortgage Program • Payment caps • Cal-Vet Purchase Program • Index • California Housing Finance Agency • Margin • Mortgage Revenue Bond Program (seller) • Graduated payment mortgage • Mortgage Credit Certificate Program (seller) • • Take-back mortgage • Growing equity mortgage • Assumptions • Balloon loan • Contract for deed • Lease-purchase agreement • Lease with option to buy

Lender Considerations

As you read, think about:

• Why real estate licensees need to understand financing • What lenders consider when looking at prospective borrowers

By knowing what lenders consider when qualifying prospective borrowers, you can more effectively qualify potential buyers. By qualifying buyers, you will eliminate wasted time and effort by helping them to identify a realistic price range from the start. To do this, you need to understand what lenders take into consideration when deciding whether to provide financing for the purchase of a residential property.

Lenders take two things into consideration: the prospective buyer and the property. The buyer's income, assets, credit history, liabilities, and debt ratios help a lender determine whether the buyer will repay the loan. Lenders also consider the appraised market value of the property, as well as the loan-to-value ratio.

Buyer Factors

Income

Lenders want to know that a borrower's income is secure, from a legitimate source, and verifiable. They prefer buyers with stable employment; frequent or recent job changes must be explained. Employment, child support, alimony, rental property income, and investment income are all examples of acceptable income sources. For income other than from employment, lenders often require documentation, such as tax returns, divorce decrees, or lease agreements. Assets

Lenders look for consistency and stability when they consider a potential borrower's savings pattern. They want to know that there will be enough funds for a down payment and closing costs, and sufficient cash reserves to cover the first two months of loan payments. Just as with income, a buyer's assets must be from acceptable sources and be verifiable. Examples of acceptable assets are cash from the borrower's savings or checking account, stocks and bonds, a gift from a relative (verified with a gift letter), or the proceeds from the sale of real property.

Credit history

The lender will obtain a report of the potential borrower's credit history from a licensed credit bureau. The credit report demonstrates a buyer's willingness to repay the loan. Lenders look to the report for indications of late payments, past due accounts, collections, or bankruptcies. If these problems exist in the report, the borrower must be prepared to explain them to the lender.

Liabilities

To help lenders determine whether a borrower will be able to repay the loan, they want to know the borrower's total current liabilities. Liabilities include installment debts (e.g., car loans), revolving account balances (e.g., credit cards), and monthly payments such as child support or alimony.

Debt Ratios

Debt ratio, the ratio of liabilities to income, is a measure used to determine a buyer's ability to repay a loan. The two debt ratio calculations used by lenders to determine if a buyer's income will cover his or her debts are 1) total monthly housing expenses and 2) total monthly expenses.

The first calculation determines housing debt ratio by dividing total monthly housing payments by monthly income:

Principal + Interest + Taxes + Insurance (plus other fees) = Total Housing Payment

Total Housing Payment / Gross Monthly Income = Debt Ratio (%)

The next calculation determines total debt ratio by dividing total monthly payments by monthly income:

Total Housing Payment + Total Monthly Liability Payments = Total Monthly Payments

Total Monthly Payments / Gross Monthly Income = Debt Ratio (%)

Below are the debt ratios considered "allowable" by lenders for different types of loans.

Conventional FHA VA

Monthly housing 25%-28% 29% N/A payment/ gross monthly income

Total monthly 33%-36% 41% 41% payments/ gross monthly income

A lender's established ratios generally cannot be exceeded unless there are compensating factors, such as a large amount of assets, an excellent credit history, a relatively high income, or a co-borrower.

Property Factors

A professional appraisal is one of the most important factors considered by lenders when determining whether to make a loan. When lenders are satisfied with the appraised market value of a property, they must next determine the maximum loan amount for that property. This amount is calculated by using what is termed a loan-to-value ratio.

Appraised market value

A lender will require an appraisal of the property that a prospective buyer intends to purchase. An appraisal lets the lender know the value and condition of the property at the time of the appraisal. If an appraisal reveals serious problems with the property, the lender might refuse to grant the loan until the problems are fixed. Appraisers determine the market value of a property by comparing it to similar properties that have recently sold in the same area. These "comparables" are that are similar in size, construction, and other features. Lenders determine the maximum amount that they will loan on a property based on the lesser of (1) the property's sales price or (2) its appraised market value.

Loan-to-value (LTV) ratio

To determine the maximum loan amount for a property, lenders use loan-to- value (LTV) ratio. The LTV ratio is expressed as a percentage; it is the percentage of the property's value that may be loaned. The LTV ratio is the loan amount divided by the lesser of (1) the sales price or (2) the appraised market value. To compute a loan using the LTV ratio, lenders use the following formula: lesser of sales price or appraised value times (x) LTV ratio equals (=) maximum loan amount.

For example, if a house was appraised at $110,000, but sold for $100,000, and the LTV ratio used by the lender was 95%, the maximum loan would be $95,000. The calculation would be as follows: $100,000 (sales price) x .95 (LTV ratio) = $95,000 (maximum loan amount). The LTV ratio is important to buyers because of its effect on the percentage of down payment required. A loan with an LTV ratio of 95% would require a down payment of 5%, while a loan with an LTV ratio of 90% would require a down payment of 10%.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. When deciding whether to make a loan, lenders consider the potential borrower's ______. a. income

b. assets

c. credit history

d. all of the above

2. In determining the maximum loan amount for a property, lenders use an LTV ratio. LTV stands for: a. lease-to-value

b. lender's total value

c. loan-to-value

d. loss-to-victory

3. Lenders look for consistency and stability when they consider a potential borrower's saving pattern. a. True

b. False

Conventional Financing

As you read, think about:

• The kinds of conventional financing available • The options available for conforming conventional loans • How private loan insurance can help borrowers with financing

There are various options for buyers who qualify for conventional loans: fixed interest rates and fixed payments, adjustable rate loans, graduated payment loans, and more. There are also conventional financing programs available for buyers who need a little extra assistance in making their purchase. Private loan insurance (PMI) is just one example of these types of programs. Knowing the available financing alternatives will make you a valuable resource for buyers who, more often than not, lack knowledge and understanding of the financing options that exist.

Conforming Conventional Mortgages

Conforming conventional loans fall under the maximum loan limit set by and , and conform to Fannie Mae and Freddie Mac's underwriting guidelines but are not insured by a government agency. The maximum loan limits for conforming conventional loans change annually; the new limits are set January 1 of every year. As of January 1, 2007, the maximum loan limits were as follows: 1-unit, $417,000; 2-units, $533,850; 3-units, $645,300; and 4-units, $801,950.

As mentioned above, the interest rate on a conventional loan can be "fixed," or it can be "adjustable." Most conforming conventional loans require a down payment of at least 5%. If a down payment is less than 20% of the purchase price, lenders of conventional loans usually require the borrower to pay for private loan insurance (PMI). The debt ratios used by most lenders for conforming conventional loans are 25% - 28% for monthly housing payments and 33% - 36% for total monthly payments.

It is a good idea to pre-qualify buyers for conventional loans because the qualifying process will be similar to other types of financing. By qualifying a buyer for a conventional loan, you will be able to determine an appropriate price range for that buyer. (See p. 83 for a sample worksheet that can be used for qualifying buyers for conventional loans.) Another useful tool for qualifying buyers is the Estimated Buyer's Costs form (EBC) (see p. 83). This helps buyers to anticipate how much money will be required up front and how much money the entire purchase will end up costing them.

Fixed Rate Mortgage (FRM)

A fixed rate loan with level payments is the most common loan option. A fixed rate loan (FRM) with level payments has an established interest rate at the start of the loan and payments that do not fluctuate in amount for the entire term of the loan. FRM's appeal to borrowers who do not want to risk rising interest rates and who do not like the idea of fluctuating payments. However, borrowers who want to be able to take advantage of lower interest rates, if they should fall in the future, might prefer to go with an adjustable rate loan (ARM).

Adjustable Rate Mortgage (ARM)

Usually, a buyer can qualify for a larger loan with an adjustable rate loan (ARM) than with a fixed rate loan. Borrowers do not need as much income to qualify for an ARM as they do for an FRM because the initial interest rate for an ARM is usually lower than the interest rate for an FRM. With an ARM, the interest rate adjusts periodically according to the changing market rates. An ARM is a good option for a borrower who, at the origination of the loan, does not qualify at the higher fixed rate, but whose income will most likely increase in the future. There are a number of factors for a borrower to consider when looking into an ARM. Borrowers should consider all of the following: the index and margin, length of the adjustment period, and interest rate and payment caps.

Index and Margin: The interest rate on an ARM is computed by using the index and margin together. The most common indexes used are U.S. Treasury Bills, U.S. Treasury Securities, Federal Home Loan Bank 11th District Cost of Funds, and London Interbank Offered Rate. The margin (a constant rate of usually 2% - 3%), is added to the index to determine the current interest rate for each adjustment period.

Length of the Adjustment Period: With most ARM's, there is an initial period of time during which the interest rate remains fixed. After this initial period, there is a specified adjustment period for the ARM. At the end of each adjustment period, the interest rate may be adjusted up or down, depending on current interest rates. Most standard ARM's remain adjustable for the life of the loan, although some lenders offer "convertible" ARM's which can be converted to fixed rate loans.

Interest Rate Caps and Payment Caps: Most ARM's have interest rate caps which dictate how much the interest rate can rise or fall during each adjustment period, as well as over the life of the loan. For example, an ARM might have an initial interest rate of 6% with an interest rate cap of 2%, and a lifetime interest rate cap of 12%. That would mean that the interest rate on the loan would never rise more than 2% per adjustment period, and would never surpass 12% during the life of the loan.

Also, instead of an interest rate cap, some ARM's have a payment cap. A payment cap limits how much the principal and interest payment can increase or decrease at each adjustment period.

Graduated Payment Mortgages (GPM's)

Another loan alternative is the graduated payment loan (GPM). A GPM is a fixed rate loan amortized over a set period of time, usually 30 years. Payments for a GPM are initially smaller and increase by a specified percentage each year during the graduated payment period. GPM monthly payments are established in advance and are not affected by interest rate changes during the life of the loan.

This type of loan might be good for a buyer who has enough cash to make at least a 10% down payment, but whose current income does not qualify him for a higher fixed rate, fixed payment loan. The borrower should anticipate regular, substantial salary increases in the future to cover the gradually increasing monthly payments.

With a GPM, the borrower needs to be aware of negative amortization. During the initial period of a GPM, the unpaid balance of the loan actually increases. The smaller payments made during the first few years do not cover interest charges, so interest is deferred and added to the principal balance. Negative amortization occurs only during the first few years of a loan. Over the lifetime of a loan, the payments even out so that all of the loan balance is paid by the end of the fixed term period.

Balloon Loans A balloon loan might be a good choice for a buyer who intends on selling the property within five to seven years. With a balloon loan, payments are usually amortized over a 30-year period, even though the remaining balance is actually due in full after a much shorter term, usually five to seven years. This results in a balloon payment at the end of that term. A balloon loan usually has a lower interest rate than a 30-year FRM because of the reduced term. However, if an owner does not sell his or her property before the end of the term, the owner will have to pay the remaining balance in full.

Conventional Financing Assistance Programs

In addition to the financing methods described above, some buyers require further assistance to make housing more affordable. Reducing the initial costs of buying a home, such as the down payment and closing costs, are often goals of financing assistance programs. Conventional financing assistance programs are offered by many private lenders. To provide your buyers with the best service possible, you should know about the financing programs offered by the savings and loan institutions, commercial banks, and loan banking companies in your local area.

The affordable financing programs discussed below, sponsored by the federally-chartered, privately-owned Federal National Loan Association (Fannie Mae) and Federal Home Loan Loan Corporation (Freddie Mac), are considered to be conventional. They are provided through private institutional lenders, not through the government. Fannie Mae and Freddie Mac purchase loans from primary market lenders (savings and loans, commercial banks, and loan bankers), who, in turn, take the funds provided by Fannie Mae and Freddie Mac purchases and loan them to home buyers in the form of new loans. Fannie Mae and Freddie Mac turn the loans into loan-backed securities, which are bought by investors.

Fannie Mae/Freddie Mac Community Home Buyer's Program

The Community Home Buyer's Program is designed to help the low- and moderate-income buyer to purchase a home. Under this program, buyers are required to attend a seminar on choosing, financing, inspecting, and owning a home. In exchange for attending the seminar, borrowers are qualified for loans under favorable underwriting criteria. With a down payment as small as 5%, the Community Home Buyer's Program allows buyers to apply up to 33% of their gross income towards monthly loan payments, instead of the 28% housing debt-to-income ratio commonly used on conventional loans. Buyers may devote up to 38% of their income towards total monthly debt service, instead of the 36% total debt-to-income ratio used for most conventional loans. Further, the Community Home Buyer's Program waives the usual qualifying condition that buyers have cash reserves equal to two monthly loan payments. Borrowers participating in the Community Home Buyer's Program may use a second loan to keep the down payment as small as possible. Finally, borrowers can use non-traditional documentation (e.g., proof of timely payment of rent and utility bills) as evidence of having a good credit history.

Fannie Mae's FannieNeighbors Loan Program

Fannie Mae recently introduced a new loan program called FannieNeighbors. The goal of FannieNeighbors is to increase home ownership in and revitalize low- and moderate-income urban areas. As with most other Fannie Mae programs aimed at low- and moderate-income home buyers, borrowers must make a down payment of 5%. FannieNeighbors loans allow for qualification under flexible underwriting guidelines. Monthly housing expenses may equal up to 33% of a borrower's gross monthly income. Total monthly debt expenses may equal 38% to 40% of a borrower's gross monthly income, depending on the borrower's individual financial situation. Additionally, FannieNeighbors borrowers may use non-traditional means of establishing a positive credit history.

Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) enables home buyers to obtain conventional loans with relatively small down payments. Prior to PMI, conventional loan lenders usually required a down payment of 20% of the home's purchase price. There is a monthly fee until 20% equity is reached. Today, however, saving enough money to make a 20% down payment is the greatest barrier to home ownership. PMI helps home buyers overcome this obstacle to home ownership by reducing the down payment required to as little as 5%. PMI is obtained by lenders to protect themselves against the costs of foreclosure. In the event of a foreclosure, PMI substitutes for the borrower's equity and covers a lender's expenses in settling the loan and selling the house.

PMI is available on a wide variety of conventional loans, including most fixed- and adjustable-rate home loans. Most lenders do not require PMI for loans with an 80% or less LTV ratio. PMI is required on all Fannie Mae and Freddie Mac purchases of loans with LTV ratios in excess of 80%. Generally, under Fannie Mae/Freddie Mac guidelines, the maximum total LTV ratio, including the financed loan insurance premium, may not exceed 95% for fixed-rate loans and 90% for adjustable-rate loans. (All of the loan insurance companies operating in California allow PMI premiums to be added into the loan amount for loans with LTV ratios of 90% or less.)

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. Conventional mortgages: a. are insured by the Federal Housing Authority

b. must conform to Fannie Mae underwriting criteria

c. are permanently set at a maximum loan limit of $200,000

d. all of the above

2. Most lenders do not require Private Mortgage Insurance (PMI) for loans with an LTV ratio of ______or less. a. 95%

b. 85%

c. 90%

d. 80%

3. Private Mortgage Insurance enables home buyers to obtain conventional mortgages with relatively small down payments. a. True

b. False

4. A balloon mortgage would be a good choice for a buyer who intends to live in the property for twenty years or more. a. True

b. False

5. A fixed rate mortgage has an established interest rate at the start of the loan and payments that do not fluctuate in amount for the entire term of the loan. a. True

b. False

6. Conforming conventional mortgages are usually insured by a government agency. a. True

b. False

Non-Conventional (Government) Financing

As you read, think about:

• How the federal government helps to provide financing • What kind of special financing is available to veterans • Financing programs offered by state and local government agencies

Non-conventional loan programs involve financing which is provided either directly or indirectly by a government agency. The agency can be an instrument of the federal, state, or local government.

Federal Housing Authority (FHA) Loan Insurance Program

The FHA Loan Insurance Program is a federal, low down payment, low closing-cost program administered by the U.S. Department of Housing and Urban Development (HUD). The FHA insures loans for the full amount made by private lenders on single-family homes and . The FHA program offers government loan insurance to all qualified home buyers who wish to participate. An FHA-insured loan may have a fixed interest rate and fixed payments, or it may be an alternative loan type, such as those described in the previous section. The relatively low purchase price limits, small down payment requirements, low closing costs, and underwriting standards used in qualifying borrowers make the FHA program attractive to first-time home buyers. No more than a 1% origination fee may be charged for FHA loans, and HUD closely restricts the closing costs that buyers may pay. The loan insurance premium (MIP) and non-recurring closing costs can be financed in the loan amount, further reducing the up-front cash demands involved in buying a home.

Maximum Loan Limits: Maximum loan limits in California in 2007 range from $200,160 in low-cost areas to $362,790 in high cost areas, based on the lesser of 95% of an area's median home price or 87% of the 2007 Fannie Mae/Freddie Mac limit ($322,700).

Debt-to-Income Ratios: The FHA uses a recommended maximum housing debt-to- income ratio of 29% and a total monthly debt ratio of 41%, which compares favorably with those for conventional loans.

Loan Insurance Premium (MIP): The loan insurance premium (MIP) comes in two forms: an up-front premium (1.5% of the base loan amount for loans closed on or after January 1, 2001) and a periodic risk-based premium. The periodic risk-based premium, 0.5% annual premium collected monthly, is paid by borrowers on terms dictated by the amount of equity in the loan and the fiscal year the loan was closed.

Loan-to-Value Ratios: Loan-to-value ratios on FHA loans, not including any financed MIP, may not exceed 97.75% for loans greater than $50,000 and 98.75% for loans less than $50,000. One of the most beneficial features of FHA financing is the low down payment required. The required down payment on FHA loans is 3% of the appraised value of the first $25,000, plus 5% of the value between $25,000 and 125,000, plus 10% of the value in excess of $125,000.

Calculating the Maximum Loan Amount: Borrowers may include up to 100% of financeable closing costs in the calculation used to determine the maximum loan amount. To calculate the maximum loan amount, borrower-paid financeable closing costs are added to the lesser of the sales price or appraised value. The result is multiplied by the appropriate LTV ratio. The closing costs to be added to the loan is the amount of the remaining total closing costs after subtracting any seller-paid closing costs.

Veterans Affairs (VA) Home Loan Guarantee Program

A VA loan is made by a lender and guaranteed up to a certain amount by the Department of Veterans Affairs. The VA guaranty is an incentive for private lenders to offer loans with more favorable terms for veterans. Under VA financing, the federal government guarantees a certain percentage of a loan's balance up to a specified dollar amount for veterans who qualify (see below). This differs from the FHA program, under which 100% of the loan is insured. As with FHA financing, VA financing is not restricted to first-time home buyers, but the majority of veterans using VA-guaranteed loans are first-time purchasers. The key benefit of VA financing is that no down payment is required.

VA-guaranteed loans are available to all veterans, except those dishonorably discharged. The minimum amount of time a veteran must have been on active duty varies during different periods. Eligibility is not subject to an expiration date. Certain spouses may also be eligible. VA-guaranteed loans are available to eligible veterans who served the required number of days in active duty during the following periods:

90 days: World War II (9/16/40 - 7/25/47) Korean Conflict (6/27/50 - 1/31/55) Vietnam Era (8/5/64 - 5/7/75) Persian Gulf War Period (8/3/90 - present)

181 days: Pre-Korean Conflict (7/26/47 - 6/26/50) Pre-Vietnam Era (2/1/55 - 8/4/64) Post-Vietnam Era (5/8/75 - 9/7/80--enlisted) (5/8/75 -10/16/81--officers)

730 days: Pre-Persian Gulf War Period (9/8/80 - 8/2/90)

The unremarried surviving spouse of an eligible veteran who died in service, or as a result of service-connected injuries, is eligible. The spouse of an active duty service member who is missing in action or who is a prisoner of war is also eligible.

Until September 30, 2007, members of the Selected Reserve who have served six years and been honorably discharged are also eligible for the VA Home Loan Guarantee Program. "Selected Reserve" refers to the Ready Reserve of any of the reserve components, including Army, Navy, Air Force, Marine Corps, and Coast Guard Reserves, as well as Army National Guard and Air National Guard.

Maximum Loan Amount: Lenders generally limit VA loans to $359,650. The entitlement is the guaranty benefit available to eligible veterans. As of 2007, the maximum entitlement for the purchase of a home over $144,000 is $89,912. For sales prices under $144,000, the maximum entitlement is $36,000. The guaranty is determined as follows:

Loan Amount Amount of Guaranty

$45,000 or less 50% of loan

$45,001 $22,500 minimum with maximum of 40% of loan or $36,000, whichever is less

Over $144,000 25% of loan or up to a maximum of $89,912

A veteran can use part of his entitlement to buy a home, and can use the remaining entitlement to buy another owner-occupied home in the future. If a veteran has used part or all of his entitlement, it may be restored if the property purchased with the prior VA loan has been sold, and the loan paid in full. The entitlement may also be restored if another qualified veteran buyer agrees to assume the VA loan, and substitutes his entitlement for that of the seller. If the entitlement is restored, the veteran can use it to purchase another property with a VA loan.

Debt-to-Income Ratios: The VA uses a total monthly expenses debt-to-income ratio of 41% to qualify buyers. Unlike conventional and FHA loans, the VA does not use a housing debt-to-income ratio in qualifying borrowers for guaranteed loans.

LTV Ratio: There is no required down payment; however, a veteran can reduce the amount of the funding fee by increasing the amount of the down payment (see p. 62).

Cost of Obtaining the VA Loan: There is no MIP on VA loans; however, there is a VA funding fee. The fee is a one-time payment, and may be financed, unless it causes the loan to exceed the maximum VA amount. Veterans with service-related disabilities and surviving spouses of eligible veterans are exempt from paying the fee.

The amount of the funding fee varies, according to the down payment. If no down payment or a down payment of less than 5% is made, the funding fee is 2%. If a down payment of at least 5%, but less than 10%, is made, the funding fee is reduced to 1.5%. If a down payment of 10% or more is made, the funding fee is reduced to 1.25%. (The funding fee is generally 0.75% higher for members of the Selected Reserve.)

The VA has tight restrictions on the closing costs that may be charged to veteran borrowers, and closing costs may not be included in the loan. These costs are at the expense of the seller. Commissions or brokerage fees may not be charged to a veteran buyer under the VA program. Therefore, the seller (whether or not a veteran) must pay any commission.

VA home loans are guaranteed at an interest rate agreed upon by the veteran and the lender. Under these negotiable rate revisions, loan discount points are negotiable and may be paid by the veteran; discount points may not, however, be financed in the loan amount.

California Home and Farm Purchase Program (Cal-Vet)

The Cal-Vet Program is basically the state version of the VA Home Loan Guaranty Program. It is administered by the California Department of Veterans Affairs, and the funds are derived from the sale of California general obligation and revenue bonds. As proceeds are needed to replenish loan funds, the bonds issues are periodically approved through ballot initiatives.

General obligation bonds may only be used to make loans to veterans who have been released from active duty for less than 30 years and who were on active duty at some time prior to January 1, 1977. Revenue bonds may only be used to make loans to veterans who are either first-time home buyers or who are purchasing a home in a federally designated "target area." For target area loans, the home selected must have a purchase price at or below federal limits, and the family income of the veteran must also qualify under federal guidelines.

To be eligible for the Cal-Vet loans for applicants who served only in peacetime, funding is limited to revenue bonds; the applicant must have served in the armed forces during certain "war periods." All eligible veterans who currently reside in California may apply for the Cal-Vet program. To be eligible, the veteran must have served at least 90 days of active duty, at least one day of which must have been during one of the following five qualifying war periods:

World War II (12/7/41 - 1/31/46) Korean Period (6/27/50 - 1/31/55) Vietnam Era (8/5/64 - 5/7/75) Operation Desert Shield/Desert Storm (8/2/90 - present) Operation Restore Hope/Somalia (Dates not specified)

Application by eligible veterans for Cal-Vet financing must be made within 30 years from the date of release from active duty. The 30-year period does not apply to veterans who were wounded in the armed service, disabled veterans, or veterans who were prisoners of war.

Interest Rates: The most appealing and beneficial aspect of Cal-Vet financing is the program's low interest rate. The funds for the program are raised through tax-exempt bonds, and the resulting savings are passed on to veterans. The current 2005 interest rate on Cal-Vet loans is 5.15% (gen. Obligation 8%, and the rate has been at 8% or less since 1982).

Maximum Loan Limits: The 2005 limit is $359,650 for most properties, but is lower in some counties.

Debt-to-Income Ratios: Cal-Vet does not use a housing debt-to-income ratio or a total debt-to-income ratio. Instead, it requires that at least 40% of a borrower's net income remain after subtracting the monthly loan payment (including principal, interest, taxes, insurance, and other long-term debt).

Down Payment: Some buyers can qualify for a no-down-payment loan. Cal-Vet loans require a 3% down payment.

California Housing Finance Agency (CHFA)

The California Housing Finance Agency (CHFA) was established in 1975 for the purpose of making and insuring below-market interest rate loans for low- and moderate-income first-time home buyers in California. As with FHA and VA loans, CalHFA home ownership loans are made directly through private lending institutions. CalHFA loans are insured by either the FHA or the CalHFA Insurance Fund. The funds for CalHFA's loans are derived from the issuance of tax-exempt loan revenue bonds. As with the Cal-Vet Program, because the interest earned on these bonds is tax-exempt, CalHFA is able to provide funds at below-market interest rates.

To be eligible for CalHFA financing, a buyer must meet the following qualifications:

• be a first-time buyer, unless the home is located in a federally designated "target area" (e.g., a census tract in which at least 70% of the households have incomes of 80% or less of the statewide median); • have an income which does not exceed federally established limits (these vary by county and size of household); • property must be owner-occupied for term of loan or until sold; • purchase a home with a sales price which does not exceed federally established limits (these vary by county and size of household); • have sufficient savings available to make a 5% down payment and pay required closing costs; • meet the underwriting standards, have a good credit history, and a good employment history; • be able to pay a 1% loan origination fee, a $350 processing fee, plus the out- of-pocket expenses of the lender; • have the legal right to permanently reside in the U.S.; and • not have previously obtained a CalHFA loan.

Apart from its below-market interest rate loan program, CalHFA offers other assistance to first-time home buyers, including help with down payments. Lower- income buyers earning 80% of median income or less may qualify for the CA Homebuyer's Down Payment Assistance Program (CDHAP). The agency will lend up to 3% of the lesser of the purchase price or appraised value by providing a second loan on the property, payable at time of sale or when the property's first loan is refinanced. Only 3% simple interest is charged on CalHFA's matching down- payment funds.

IMPORTANT NOTE: CalHFA loans are subject to a federal recapture tax. This recapture tax is a federal income tax that borrowers may have to pay if they sell or transfer their CalHFA-financed home within nine years of having purchased the home and realize a gain on sale.

Mortgage Revenue Bond Program (MRB)

Under the Mortgage Revenue Bond Program (MRB), state and local housing finance agencies issue loan revenue bonds and use the proceeds to provide low-interest loans (as much as 2.5% below prevailing rates) to low-income buyers. Borrowers obtain loans at below-market interest rates and may be eligible for down payment and closing cost assistance.

MRB assistance is limited to first-time buyers, low-income households, and low-priced homes. Borrowers must not have owned a home during the past three years, unless the property is located in a target area. For a family of three or more, the household income cannot exceed 115% of the state or area median income, whichever is greater. (For homes in targeted areas, the limits are 140% and 120%.) The sales price of a single-family home cannot exceed 90% of the average purchase price in the area (110% for targeted areas).

These issuers include counties, cities, redevelopment agencies, and housing authorities. As with Cal-Vet revenue bonds, loans made with MRB funds have lower interest rates because of the fact that the interest on the bonds is tax exempt to investors.

Mortgage Credit Certificate Program (MCC)

The Mortgage Credit Certificate Program (MCC) allows a low-income home buyer to claim a credit on her federal tax return. The same eligibility requirements which apply to home buyers under the MRB program also apply to the MCC program.

MCC recipients can claim a credit on their federal tax returns for a specified percentage of the annual mortgage interest they have paid, up to a maximum credit of $2,000 per year. An MCC is non-refundable and can only reduce a taxpayer's bill to zero. However, unused credits can be carried forward for up to three years. Because MCC's offer tax credits, they are most useful to households at the upper end of the MRB/MCC income range. Just as with the MRB program, borrowers in the MCC program may incur a federal recapture tax when selling the property.

Currently, close to 20 localities and counties in California have MCC programs. MCC programs are generally administered by local housing finance agencies or redevelopment agencies. Local agencies work together with private lenders to issue MCC's. A buyer applies for a mortgage from a private lender involved in the local MCC program. The lender assesses whether or not the buyer meets the program's requirements. If the buyer meets the program's requirements, the lender sends the application to the administering authority. If the application is acceptable and approved by the administering authority, the agency commits to the MCC and, upon closing of the transaction, issues an MCC to the buyer. MCC's are in effect for the full life of the mortgage, provided the home remains the buyer's principal residence.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. The California Housing Finance Agency (CalHFA) was established for the purpose of making and insuring below-market interest rate mortgages for low- and moderate-income first-time buyers in California. a. True

b. False

Seller-Assisted Financing

As you read, think about:

• How sellers can make a purchase more affordable for buyers • The various seller-assisted financing options

As previously mentioned, a common stumbling block for buyers is the lack of funds for down payments or closing costs. Seller-assisted financing can allow lower cash requirements, making a purchase more attractive and affordable. Below are several seller-financing techniques that you may want to discuss with your sellers. However, as a real estate professional, you should be careful not to give legal or tax advice to your clients. If your sellers are considering one of the seller-assisted financing techniques listed below, you should advise them to consult their attorney or C.P.A.

Seller Carry-Back Loans

A seller carry-back loan is a loan made by a seller to a buyer. This type of financing requires the seller to have enough equity in the property, or sufficient other assets, to make a loan to the buyer. Usually, a seller carry-back loan is a "second loan," in addition to the buyer's loan from a traditional lender. Occasionally a seller may carry-back the first loan, which is, in effect, lending the buyer the entire amount needed to buy the house.

With a seller carry-back loan, the home will probably sell faster, as it will make a purchase more affordable, increasing the number of potential buyers. Also, the seller may be able to negotiate a higher interest rate than he would earn on another investment. A further benefit to the seller is that taxes on a portion of the profit may be deferred and paid as the purchase price is received in installments.

As a professional real estate agent, if you inform your sellers about the advantages of seller carry-back loans, you should also advise them about the risks. For example, if a buyer is not investing much of his own money, there is usually a greater default risk for a seller. And, if a buyer defaults on the loan, the seller will have to foreclose on the property. In addition, the seller will not receive "all cash" from the transaction and should be prepared to hold the loan note for some time. Also, sellers are less able than traditional lenders to evaluate the creditworthiness of a buyer. The seller should record a trust deed on the property and request notification of default from any holder of liens with a superior interest.

Assumptions

An assumption is a financing technique in which a home buyer takes over the seller's existing mortgage and continues to make the monthly payments. The key advantage of an assumption is that the buyer does not have to qualify with an institutional lender for a new mortgage loan.

Not all mortgages are assumable; most conventional mortgages are not because the existing mortgage contains a provision known as a "due-on- sale" clause. This clause gives a lender the option to require a seller to pay the entire remaining balance on the mortgage when the property is sold. Some conventional lenders might be willing to allow an assumption if the creditworthiness of the buyer is established and the interest rate is brought to current market rate (if current market rate is higher). Lenders may also charge assumption fees. To determine if an existing loan is assumable, the promissory note and the loan or deed of trust must be evaluated.

FHA and VA loans are generally assumable; however, there are restrictions placed on both. FHA loans originated before 1989 and VA loans originated before 1988 are "freely assumable." However, on FHA and VA loans originated after these dates, the creditworthiness of the proposed assumptor must be approved by the lender.

If a moderate-income or first-time buyer has trouble obtaining new financing because of poor credit, or if higher interest rates reduce the affordability of new financing, an assumption might be the answer. A buyer intending to assume an existing loan must have either sufficient cash to pay a seller the difference between the sale price and the existing loan balance or the means to obtain financing. Either the buyer will make a large down payment to cover the difference between the sales price and the existing loan balance, or he will have to obtain a second loan from the seller or another lender to finance the seller's equity.

Sellers, beware!

It is important to let your sellers know that when a buyer assumes a loan, the seller may or may not be able to obtain a release of liability, depending on the terms of the loan. Even if the conditions to release a seller from liability are met, a release of liability must be requested from and approved by the lender.

Contract for Deed

With a contract for deed, or installment land sale contract, a seller promises to convey title when the purchaser fulfills the obligation called for in the contract. The contract usually requires the buyer to make predetermined installments to the seller until the amount of the purchase price is paid (or until the buyer obtains financing to pay the seller in full). Once the seller has been paid in full by the buyer, he must convey the title, without liens, to the buyer.

IMPORTANT NOTE: The contract for deed is a legally binding contract which constitutes an actual sale, and the seller must be aware that although title does not transfer to the buyer until all contractual obligations are met, the sale may trigger a due-on-sale clause in the existing loan. If so, the seller may be required by the lender to pay off the balance of the mortgage.

There are some advantages to the seller in using a contract for deed. It can allow for the quick disposition of the seller's property. However, the seller will not receive all cash from the transaction, and there is the possibility that he will have to repossess the house if the buyer fails to make his installment payments.

A contract for deed would appeal to a buyer who wants to purchase a property but cannot qualify for the mortgage. However, the buyer should be confident in his ability to make the installment payments; if occurs, he could lose all or part of his equity at stake, in accordance with the laws governing installment land sale contracts for deed.

Lease with Option to Buy

An agreement to lease with the option to buy gives a tenant the choice or option of buying the home the tenant is . Renters who want to become homeowners, but who do not have the funds for a down payment, might find this alternative appealing. One way for a lease with an option to be structured is for a portion of the tenant's monthly rent to be applied toward the down payment, if and when the option is exercised. The amount to be applied depends on how the agreement is written. Often, the seller puts an agreed-upon portion of the rent into an escrow account. The option will give the tenant the right to purchase the property on agreed-upon terms. If the tenant decides to exercise the right to purchase, the parties will proceed as Seller and Buyer under the terms of a purchase contract. If the tenant decides not to exercise the right to purchase the property, money paid for rent or option is generally not refunded to the tenant.

Lease-Purchase Agreement

A lease-purchase agreement is not the same as a lease with option to buy. With a lease-purchase agreement, a buyer agrees to rent property from the seller until a predetermined time, at which point the buyer will purchase the property. A lease-purchase agreement is basically appealing to a buyer for the same reasons as a lease with option to buy; however, the buyer should be sure that she wants to purchase the property when the lease expires because a lease-purchase agreement is binding. The buyer has a legal obligation to follow through with her commitment to buy the property. (Of course, contingencies listed in the contract, such as the buyer not being able to obtain financing, may nullify the contract.)

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. An agreement that provides for a buyer to rent a property from the seller until a predetermined time, at which point the buyer is required to buy the property, is known as a: a. contract for deed

b. lease with the option to buy

c. lease-purchase agreement

d. shared equity agreement

Other Financing Techniques

As you read, think about:

• The non-loan products available that can help make a property more affordable

Aside from seller-assisted financing, there are numerous other "creative" financing techniques that are not loan products that may help make a property more affordable for a buyer. Two such examples are described below: buy-downs and shared equity arrangements.

Buy-downs

With a buy-down, interest is prepaid in order to reduce the monthly loan payments. A temporary buy-down reduces the interest rate only for the first few years, while a permanent buy-down reduces the interest rate for the life of the loan. The cost of a buy-down may be paid by any party, including:

• a seller who wants to make the property more attractive to buyers; • a buyer who has substantial cash, but a smaller income, and wants to reduce monthly payments; or • another donor who wants to make the purchase more affordable for the buyer (e.g., a parent).

Temporary Buy-downs: In a temporary buy-down agreement, the prepaid interest is held by the lender in an escrow account, and a portion of it is withdrawn each month to subsidize the borrower's reduced monthly payment. There are several options with temporary buy-downs. For example, with a "2-1 buy-down," the first year's interest rate is 2% below the actual loan rate, and the second year's interest rate is 1% below the actual loan rate. At the end of the second year, funds in the buy-down escrow account are exhausted, and, for the rest of the term, the interest rate charged is the actual mortgage rate.

Permanent Buy-downs: In a permanent buy-down agreement, interest is prepaid in the form of discount points to reduce the interest rate for the life of the loan. (A discount point is equal to 1% of the loan amount.) The more discount points paid, the lower the interest rate charged.

Shared Equity Arrangements

A shared equity arrangement is an agreement between a borrower (owner- occupant) and an investor. Under a shared equity arrangement, an investor provides funds to pay for a specified share of the borrower's expenses in exchange for a share of the property appreciation and tax benefits. The investor might pay for all or part of the down payment, closing costs, or loan payments.

Usually, shared equity arrangements are made between family members, with the parent as the investor and the child as the owner-occupant. A shared equity arrangement is an agreement between two parties who apply as co-borrowers to a loan lender for the type of loan that best suits their needs; the arrangement itself is not a type of loan. The shared equity agreement exists separately from any financing arrangements made through the loan lender. However, because the owner-occupant and investor are co-purchasers, the lender holds both responsible for the full loan amount. A wide range of possible cost and equity splits exist, and arrangements depend heavily on the tax code; therefore, an experienced attorney should be consulted.

Financing Laws and Regulations

As you read, think about:

• The financing laws and regulations of which licensees should be aware to avoid disciplinary action

There are numerous laws related to the regulation of financing. These laws cover the many aspects of financing, from discrimination in lending to disclosure, to advertising, and more. Described below are several of the most important laws and regulations of which real estate licensees should be aware.

The Broker's Loan Law (Business & Professions Code §10240 and §10241)

Real estate brokers who negotiate loans in any amount, to be secured directly or collaterally by a lien on real property, must, before the borrower becomes obligated to complete the loan, deliver to the borrower a Loan Disclosure Statement in prescribed form, such as C.A.R. Form MS, containing specified information. The purpose of this statement is to provide a buyer with information concerning the features of a loan to be negotiated for that buyer.

The law covers any loan in any amount negotiated by a real estate broker (or a salesperson on behalf of a broker). The licensee must certify compliance with specified provisions of the law only if the loan is a first trust deed loan under $30,000 or a junior loan under $20,000. The certification language in the Loan Disclosure Statement which is required by Section 10240 has been amended in Regulation 2840 to read:

If this loan is secured by a first deed of trust on dwellings in a principal amount of less than $30,000 or secured by junior lien on dwellings in a principal amount of less than $20,000, the undersigned licensee certifies that the loan will be made in compliance with Article 7 of Chapter 3 of the Real Estate Law.

*This loan may/will/will not (delete two) be made wholly or in part from broker-controlled funds as defined in Section 10241(j) of the Business and Professions Code. *NOTICE TO BORROWER: This disclosure statement may be used if the broker is acting as an agent in arranging the loan by a third person or if the loan will be made with funds owned or controlled by the broker. If the broker indicates in the above statement that the loan "may" be made out of broker- controlled funds, the broker must notify the borrower prior to the close of escrow if the funds to be received by the borrower are in fact broker- controlled funds.

Federal Truth in Lending Act (Regulation Z)

The Federal Truth in Lending Act is administered by the Federal Reserve Bank Board. The law requires compliance by real estate licensees acting as "creditors" to furnish Truth in Lending disclosures to consumers. For the purposes of the Act, a creditor is a licensee who extends credit more than five times a year for transactions secured by a dwelling.

Among the required items, the Truth in Lending disclosure must include: identity of the creditor, the amount financed, the finance charge (including interest and fees), Annual Percentage Rate (APR), and the payment schedule. On residential loan transactions in which a security interest is taken in a dwelling, disclosure must be made before consummation of the credit transaction or within three business days after receiving the consumer's written application, whichever is earlier.

The law also requires (with some exceptions) that the creditor provide the consumer with two copies of a Notice of Right of Rescission in a transaction in which a security interest will be taken in a consumer's principal dwelling. The consumer has the right to rescind until three business days following: 1) the consummation of a transaction, 2) the delivery of Truth in Lending disclosures, or 3) the delivery of the notice of right to rescind, whichever occurs last.

Disclosures: A creditor must furnish the borrower with a Truth in Lending disclosure. This disclosure statement is not required to be in any particular form or format but must contain (among other things) amount financed, including:

• amounts paid to others on the consumer's behalf, such as appraisal, credit reports, etc. • finance charge (including interest, loan fees, assumption fees, finder's fees, buyer's points, and premiums for loan insurance) • finance charge expressed as an annual percentage rate • variable rate disclosures (if an ARM) • payment schedule • total of payments

Advertising: A real estate licensee may not advertise credit information, unless the advertising complies with the Truth in Lending Act. If only the APR is disclosed, additional disclosures are not required. However, if any of the following terms are described, then additional credit terms must also appear. The triggering terms are:

1. amount or percentage of any down payment, 2. number of payments or period of repayment, 3. amount of any payment, or 4. amount of any finance charge.

The additional disclosures to be made are:

• amount or percentage of any down payment, • terms of repayment, and • annual percentage rate.

Real Estate Settlement Procedures Act (RESPA)

One of the main purposes of the Federal Real Estate Settlement Procedures Act (RESPA) is to provide buyers with information to take the mystery out of closing costs and assist them in obtaining the best value in settlement services for the money spent.

Under RESPA, lenders are required to distribute information booklets authorized by HUD and provide a good faith estimate of closing costs to borrowers before the close of escrow. Among other things, the booklet describes the settlement process and the nature of the charges which are generally incurred by the principals in the transaction. The booklet sets forth information as to rights and remedies available under RESPA. It describes unfair or illegal settlement practices and provides an item-by-item explanation of closing costs and services.

The Act covers the sale or transfer of one-to-four unit family residential property (homes, condominiums, cooperatives) financed by federally related loans. RESPA also regulates the maximum amount a lender can require a borrower to deposit in escrow impound accounts. RESPA prohibits the giving or receiving of any compensation for the referral of any settlement service business. The provisions of RESPA extend to second mortgages, property improvement loans and home equity loans.

Seller Financing: Parties Responsible for Disclosure (Civil Code §2956)

Under Civil Code §2956, disclosure requirements are stated for seller financing. In a transaction for the purchase of one-to-four unit family residential property, in which there is an arranger of credit and the seller extends credit, a written disclosure must be made. The arranger of credit (generally the real estate agent representing the buyer) and the seller must make a written disclosure to the buyer. Also, the buyer and the arranger of credit must make a written disclosure to the seller. Disclosure must be given before execution of the note. The buyer and the seller must give a written receipt for the disclosure, and the arranger of credit must keep a copy for three years.

The disclosures required are included in C.A.R.'s Seller Financing Disclosure Statement (SFA), and include:

• identification of the note and of the property used as security; • description of the terms or a copy of them; • description and conditions of each recorded senior lien; • any cash that the purchaser is to receive; • a warning of difficulties that may arise in if full amortization does not occur; • a disclosure that negative amortization can occur; • possible acceleration clauses; • possible balloon payments; • information about the credit history of the borrower, the borrower's income and a warning about deficiency judgments; • loss-payee clauses in insurance; • coverages; • tax service; and • the importance of recording the note.

Discrimination in Lending

A number of state and federal laws prohibit discrimination by a lender on the basis of such factors as the borrower's race, sex, marital status, and age; or on such factors as the location of property offered as , or the race or family status of would-be occupants of the property. Some of these laws are described below.

Federal

The Equal Credit Opportunity Act prohibits discrimination in the extension of credit. The Act dictates what information may be solicited in an application for credit, how a lender may proceed in evaluating an applicant's creditworthiness and in making a decision whether to extend credit or not, and what a lender may or must do after a decision is made.

The Fair Housing Act Amendments of 1988 broaden protected classes to explicitly include families with children and the physically or mentally disabled. In addition, the revisions substantially increase the fines that can be levied for fair housing violations and provide HUD with the power to represent discrimination victims in court in individual cases, not just in so-called "pattern and practice" cases. Finally, the Fair Housing Initiatives program provides federal funding to private fair housing groups to fund local testing efforts to discover fair housing abuses.

California

The Fair Housing Act prohibits discrimination against any applicant for financing in the purchase of any housing accommodation on the basis of race, color, religion, sex (including gender identity), sexual orientation, marital status, national origin, ancestry, familial status, or disability.

The Housing Financial Discrimination Act of 1977 prohibits the practice of "redlining." Redlining consists of blocking off entire areas of a city or county and refusing to lend on the security of property within such areas, solely because of the location of the property relative to other properties occupied or owned by certain groups or kinds of people.

The Unruh Civil Rights Act expresses a policy of nondiscrimination in very broad terms, applicable to all business establishments of any kind whatsoever, and prohibiting certain discrimination in the rendering of "services" without further specification.

Summary

The information covered in this chapter should help you to answer your buyers' questions about the many financing options available today. We covered the criteria used by lenders so that you will be able to pre-qualify your buyers for financing. We also discussed the various conventional financing options, such as fixed-rate loans, adjustable rate loans, and graduated equity loans. You learned about non- conventional financing options as well, such as FHA and VA financing. The information provided on seller financing should help get you started in explaining to sellers how they can make a purchase more affordable and attractive to a buyer who might have difficulty coming up with a down payment. We also covered some of the most crucial financing regulations and legislation that, as a licensee, you should be aware of in order to avoid disciplinary action. The more knowledgeable you are about the many financing options available today, the better you will be able to help your buyers complete their purchases.

Appendix

Commonly Asked Questions About Financing

1. Q: With seller financing, what protects the seller's right to receive payments? A: The seller normally receives a promissory note secured by a deed of trust. The deed of trust is recorded against the property at the same time as the seller's deed to the buyer, at close of escrow. The deed of trust is the most common type of "security instrument" used in California. If the buyer fails to make payments when due, the seller can start a foreclosure against the property. In most circumstances, foreclosure is the seller's only legal remedy. 2. Q: Is there any minimum or maximum amount that should be paid as a down payment when seller financing is used? A: There is no "legal" minimum or maximum. This is a matter of business judgment for the seller. The higher the down payment, the less likely the buyer is to default. Sellers may also consider the lack of personal liability of the buyer in deciding on an acceptable down payment. 3. Q: Is there a minimum or maximum legal interest rate on seller financing? A: No. Seller financing is not subject to a minimum or maximum rate of interest under California law. However, the seller will be treated for tax purposes as having received interest at a required minimum rate. In general, the minimum rate is the lower of 9% per year, or the current "Applicable Federal Rate" published by the U.S. Treasury Department. 4. Q: What is "creative financing" and why is it used? A: "Creative financing" is a loose term that covers many different types of financing arrangements. The term has no specific legal meaning. Creative financing is frequently used when financing is not readily available through a "regular" source. Examples include transactions with very low down payments and financing for buyers with a negative credit history. 5. Q: When must a real estate broker provide Regulation Z disclosures? A: Generally speaking, a real estate broker must provide Regulation Z disclosures when lending the broker's own funds if the broker extends consumer credit secured by residential real property more than five times per year. Even if not personally required to provide Regulation Z disclosures, a real estate broker acting as an agent of a borrower, lender, or both, should take steps to ensure that the lender involved in the loan transaction provides any required disclosures.

Exhibits for This Chapter

Exhibit 2.1 - Conventional Loan Qualifying Worksheet To view the PDF file of the Qualifying Worksheet, click the link below: Qualifying Worksheet: Conforming Conventional Loan

Exhibit 2.2 - Estimated Buyer Costs (C.A.R. Form EBC) To view the PDF file of C.A.R. Form EBC, click the link below: C.A.R. Form EBC

Exhibit 2.3 - FHA Qualifying Exhibit To view the PDF file of the F.H.A., click the link below: FHA

Exhibit 2.4 - VA/FHA Costs Buyer's Costs and Seller's Costs To view the PDF file of the VA and FHA Costs, click the link below: VA/FHA Costs

Exhibit 2.5 - Option Agreement (C.A.R. Form OA) To view the PDF file of C.A.R. Form OA, click the link below: C.A.R. Form OA

Exhibit 2.6 - Seller Financing Addendum and Disclosure (C.A.R. Form SFA) To view the PDF file of C.A.R. Form SFA, click the link below: C.A.R. Form SFA

Exhibit 2.7 - Mortgage Loan Disclosure Statement (C.A.R. Form MS) To view the PDF file of C.A.R. Form MS, click the link below: C.A.R. Form MS

Taxation of Owner-Occupied Residential Property

Introduction

The impact of taxation on real estate transactions weighs heavily on decisions to buy and sell real estate. Although tax consequences are not usually the sole criteria in deciding whether to buy or sell a home, they are of great importance. Both buyers and sellers must consider the potential tax results inherent in any real estate transaction. The field of taxation is detailed and complex; however, a basic understanding of real estate and income tax laws has become a necessity for the successful real estate licensee. It is important for real estate licensees to know the variety of taxes, their bases, and their effect on property transfers so that they may be able to counsel their clients correctly in this area. Brokers and their clients will often have to work along with accountants, attorneys, and others who specialize in the field of taxation.

Objectives

After studying this chapter, you will be able to:

• Explain when and how real property is assessed or reassessed • Identify Propositions and Acts related to the taxation of real property • Determine whether a property qualifies as an owner's principal residence • List expenses associated with owning a personal residence that are deductible • Calculate the gain or loss on the sale of an owner's principal residence • Determine whether a seller can exclude the gain realized on the sale of his or her principal residence • List the advantages of using the installment method for reporting gain

Key Terms/Concepts

The following are the key terms and concepts found in this chapter:

• Assessment • Adjusted selling price • Ad valorem • Basis • Documentary transfer tax • Depreciation • Community facilities districts • Adjusted basis • Notice of Special Tax • Principal residence • Exclusion rule • Gross selling price • Installment sale • Selling expenses • Installment method • Fixing-up expenses • Roll-over

Assessment and Payment of Property Taxes

As you read, think about:

• The property assessment process • The circumstances that do and do not require a reassessment of real property

When Property Is Assessed for Taxation

The tax year is based on a fiscal year of July 1 to June 30. Property taxes become a lien on property on March 1 preceding the beginning or end of the tax year. The assessment period begins as of this lien date. During this period, the office of the County Assessor sets a valuation on the property for tax purposes. The tax rate is approved by the Board of Supervisors by September 1, and the Tax Collector is required on or before November 1 of each year to mail a tax bill or copy of it to each fee owner of the property.

Changes in ownership will result in a reassessment of the property which may result in a tax increase. The following will generally result in a reassessment of the property:

• Traditional sale of real property from present owner to new owner • Creation or transfer of a leasehold with a term of 35 years or more • Transfer of lessor's interest in real property subject to a lease with a remaining term of less than 35 years

The following will generally not result in a reassessment of the property:

• Creation of joint tenancy with original owner remaining on title • Creation of a life estate if the estate is reserved in the transferor or transferor's spouse • Owners of tenancy in common creating a joint tenancy • Transfer of property between spouses • Partnership owners adding a partner • Transfer of property to a revocable trust • Transfer of separate property to a spouse • Transfer to trustee for beneficial use of a spouse • Property settlement or dissolution decree transfers • Transfer due to the death of a spouse • Transfer of property (only principal residence/or first one million of real property) between parents and children (grandparents and grandchild if both parents are deceased)

How Property Is Assessed for Taxation

Property is assessed at 100 percent of taxable value. The California Constitution requires that all property be taxed in proportion to its value; such a tax is called an ad valorem tax (according to value). Value is based on market value. California law dictates a 1.25 percent of market value tax limit (1% state, 0.25% county); therefore, property owners pay the same basic tax rate of 1.25 percent of total assessed value and special assignments.

County Assessors divide the property value between land and improvements. Both amounts are shown on the tax bill and then added together to arrive at full value. The percentage of the total value assigned to land and improvements may vary considerably among different properties and locations. The percentage valuation is determined locally by the County Assessor. When Property Taxes Must Be Paid

The real property owner may pay his taxes in a single payment, or he may pay in two installments. The first installment is due on November 1, and covers the period of July through December. The first installment becomes delinquent if not paid by December 10, at which time a penalty of 10% is added to the first installment. The second installment of the real property tax, which covers the period of January through June, is due on February 1 and becomes delinquent if not paid by April 10.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. The property tax year is based on the fiscal year of: a. January 1 to December 31

b. June 1 to May 31

c. July 1 to June 30

d. April 16 to April 15

California Residential Real Property Tax Laws

As you read, think about:

• Some of the most important Propositions and Acts related to the taxation of real property

Practically all real estate transactions are influenced to some degree by tax laws. In fact, often it is the effect of property and/or income tax laws that determines the type of real estate transaction in which a buyer or seller will become involved. Tax laws affect real estate dealings before acquisition, during ownership, and at the time of disposition. These laws are quite complex, and often California's laws are different from federal laws. The following provides an introduction to some of the most important California tax laws related to real property. However, real estate licensees and their clients should seek the advice of a tax expert, such as a Certified Public Accountant (CPA) or tax attorney, when attempting to determine the impact of taxation on a real estate transaction.

Proposition 1-A

Proposition 1-A, enacted in 1968, and subsequent additions provide that a dwelling occupied by an owner as his principal place of residence will receive an exemption of $7,000 in assessed value.

Proposition 13 Proposition 13, enacted in 1978, affected the following regarding real property and taxation:

• Limited the amount of property taxes that can be collected by local governments; • Restricted the growth in the assessed value of property subject to taxation; • Required a two-thirds vote of the Legislature to increase State tax revenues; • Authorized local governments to impose certain non-property taxes if two- thirds of the voters give their approval in a local election.

Proposition 58

Proposition 58, enacted in 1986, provides for the following transfers of real property to be free of any reassessment:

• Transfer of property between spouses; • Transfer of a personal residence from parents to children; • Transfer of a personal residence from children to parents; • Transfer of up to $1,000,000 of additional real property from each parent to child/children.

Proposition 60

Proposition 60, enacted in 1986, gives relief from reassessment to certain individuals who sell a principal residence and purchase another. The law applies to individuals over 55 years of age and allows for the transfer of the assessed value of the old property to the newly acquired property. The law places the following requirements on the replacement property:

• It must be located in the same county as the original property; • It must be purchased or newly constructed within two years of the date of sale of the original property; • Its value must be equal to, or less than, that of the original property; • It must be owner-occupied and the principal place of residence of the purchaser.

Proposition 90, enacted in 1988, is similar to Proposition 60, but gives each county the option of whether or not to adopt the ordinance. Proposition 90 allows the transfer of the assessed value of the old property to newly acquired property when seniors move from one county to another. Counties accepting as of 2005 include: Alameda, Los Angeles, Orange, Santa Clara, San Diego, San Mateo, and Ventura.

Revenue and Taxation Code §11911 (Documentary Transfer Tax)

In 1968, Revenue and Taxation Code §11911 was enacted, authorizing cities and counties to charge a documentary transfer tax at a rate of $.55 per $500 on the value of real property exclusive of liens and remaining at the time of sale. A city within a county that has adopted a transfer tax may also adopt its own transfer tax ordinance with the tax fixed at half the rate charged by the county. In effect, this merely means that the county collects the total tax and turns half the amount over to the city. Mello-Roos Community Facilities Act

In 1982, the State Legislature enacted the Mello-Roos Community Facilities Act, providing local governments with a more versatile tool to aid in the construction and maintenance of local public facilities. The Act allows local governments to create community facilities districts and levy special taxes. The taxes can then be used to repay bonds floated to finance public facilities. Under Mello-Roos, a taxed property does not need to directly benefit from a facility; therefore, facilities with broad community benefits, such as libraries and city buildings, can be financed. In addition, the annual amount of Mello-Roos assessments is permitted to vary over time, but it may not exceed the maximum annual tax stipulated in the original measure approved by the voters.

Improvement Bond Act of 1915

The Improvement Bond Act of 1915 permits cities to make assessments and issue serial bonds to pay the costs in any of the streets, avenues, lanes, alleys, courts, and any public places or public ways of the city.

Civil Code §1102.6b

Civil Code §1102.6b requires that notice be given about the presence of Mello-Roos assessments prior to the completion of a sale. When a property subject to a Mello-Roos assessment is being sold, the seller must make a "good faith effort" to notify the buyer by providing him or her with a Notice of Special Tax from the agency levying the assessment. Upon request, the local agency levying the Mello-Roos or the Improvement Bond Act of 1915 assessment must furnish the seller with the Notice of Special Tax. When the buyer receives the Notice, he or she has a right of recision for three days and can terminate the purchase agreement, based upon buyer's approval of the Notice.

A seller can determine if his or her property is located within a Mello-Roos or Improvement Bond Act of 1915 district by examining the annual property tax bill or by checking the preliminary title report.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. The transfer of property between spouses will usually result in a reassessment of property for tax purposes. a. True

b. False

2. Proposition 13 limited the amount of property taxes that can be collected by local governments. a. True

b. False

Real Estate Held for Personal Use

As you read, think about:

• The definition of "principal residence" • Income tax deductions associated with owner-occupied real property

Classification of Real Property

For tax purposes, it is essential for a property owner to correctly identify the classification of property he or she owns. This chapter covers the taxation of property which is used solely as the owner's principal residence. However, the tax aspects of personal residences can sometimes be complicated.

The Internal Revenue Service needs to know whether or not a property is a taxpayer's principal residence. In addition, there are several other classifications that the IRS looks at concerning the taxation of residential properties. For example, the type of property is important, as is whether or not the owner meets certain ownership and occupancy requirements. Another area of concern is whether a personal residence is also being used for business purposes.

Definition of Principal Residence

A taxpayer's principal residence is not always easy to determine. A taxpayer cannot have more than one principal residence at any one time. In general, the principal residence is considered to be the land and building where the taxpayer principally lives. The principal residence will usually be the home in the area where the taxpayer works, votes, pays taxes, and spends the most time. A personal residence can be a single-family house, condominium, cooperative, or manufactured home; it can also be a boat, houseboat, house trailer, or motor home that contains sleeping space and toilet and cooking facilities.

Sometimes a property is only partially a residence. A typical example is a home office, or the rental of a vacation home when not being used by the owner. Another example would be an owner of an apartment building who lives in one of the units. Often, the sale of an apartment building in which the owner lives is treated as though it were a sale of two properties. There are a number of circumstances that would require the special treatment of a residential property for tax purposes, and property owners should seek the advice of their tax consultants when contemplating the sale of such properties.

Income Tax Deductions from Real Estate Held for Personal Use

Real estate held for personal use does not result in as many tax deductions as real estate held for business purposes or for the production of income. The Internal Revenue Service does not generally allow personal, living, or family expenses to be deductible. Therefore, repair, maintenance, and upkeep expenses for personal residences are not deductible. In addition, owners of property held solely for personal use may not take a deduction for depreciation. When the property is sold, any loss incurred is not deductible; however, a gain is taxed unless it can be excluded. (The exclusion of gain will be discussed in a later section.)

Certain expenses are deductible, regardless of the personal use of the residential property. For most taxpayers, all of the loan interest paid on a loan for the purchase of a first or second home is fully deductible. The total amount of purchase money debt for which a homeowner may deduct the interest is $1,000,000. This applies in aggregate to the principal and second residence of the taxpayer. In addition, interest on another $100,000 of debt secured by real property is deductible.

Real property taxes on a home are also deductible, if the owner has not taken the optional standard deduction. Also, if a loss is caused by theft, storm, fire, or some other casualty, the property loss is deductible.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. For most taxpayers, all of the mortgage interest paid on a loan for the purchase of a principal residence is fully deductible. a. True

b. False

The Computation of Gain or Loss

As you read, think about:

• Why sellers must know how to calculate gain or loss • Which expenses decrease gross selling price • The difference between original cost and basis • The effect of improvements and depreciation on basis

Calculating for Gain or Loss

When a property is sold, the seller must calculate the gain or loss to determine the tax implications. To calculate the gain or loss on any sale, the seller can use the following basic formula:

Calculating for Gain or Loss

Gross Selling Price + $______Less: Selling Expenses - ______Equals: Amount Realized = ______

Less: Adjusted Basis

Original Cost (or Basis) $______Plus: Improvements +______Less: Accumulated Depreciation -______Equals: Total Adjusted Basis =______Net Gain (or Loss) on Sale (Amount = $______Realized minus Total Adjusted Basis)

Following is an explanation of each of the terms in the gain or loss calculation.

Gross Selling Price

For tax purposes, the amount realized on a sale (gross selling price), includes the amount of cash received plus the fair market value of any other property received. The value of the loan(s) on the property sold that the purchaser either assumes, or takes" subject to," is also figured into the sales price. The selling price does not include amounts received for personal property.

Selling Expenses

Selling Expenses are all the expenses incurred by the seller to complete the sale. Selling expenses reduce the selling price. Deductible selling expenses might include any of the following:

• Real estate sales commission • Points paid by the seller to the buyer's lending institution • Attorney and accountant's fees • Settlement charges • Closing fees • Appraisal fee • Advertising • Escrow fees • Title search, examination, or insurance • Recording fee • Transfer tax • Pest inspection

Selling expenses do not include: • Expenses that physically affect the property (e.g., repairs or improvements) even if they are to prepare the property for sale • Prorated items, such as taxes, insurance, interest, and rent • Finance charges paid by the buyer

Adjusted Selling Price

The adjusted (or net) selling price is the gross sales price of the old residence, less the selling expenses.

Basis

The original basis is the original purchase price or cost to the taxpayer. In most cases, basis is the original purchase price. However, there are many ways of acquiring property, each requiring a specific method of determining the cost basis. The manner in which the property is acquired determines its basis. Property received as a gift or by inheritance does not have an original cost. If property is inherited, the basis is usually its fair market value at the time of the decedent's death.

The basis of property is a key figure in computing the gain or loss when the property is sold; taxpayers should probably consult a tax expert if the property was received or acquired:

• For services rendered • In a trade • In a nontaxable exchange • By gift • From a decedent • As property to replace seized or destroyed property

Purchase expenses are added to the basis; they include settlement fees and closing costs the seller paid for buying the old residence, such as:

• Attorney fees • Escrow fees and recording costs • Broker's fees • Surveys • Charges for title search and title insurance

Improvements

The cost or basis must be adjusted for any expenditure for improvements made to the property since it was acquired. The cost of permanent improvements to the property is added to the basis, as are special assessments paid for local benefits that improve the property. Improvements do not include "repairs" which maintain the home but do not add to its value. Do not add repair costs to basis.

Depreciation When property has been continually occupied by the taxpayer as his or her personal residence, no depreciation is allowed. However, if the property has been changed from residential to rental property, an adjustment for depreciation should be made, but only from the date of the change. If rental property is converted to a personal residence, adjustments to basis for depreciation end on the date of the conversion.

Adjusted Basis

Adjusted basis is the original cost or basis of a property, plus the value of improvements made on the property, minus depreciation and losses taken while owning it.

Determining Gain or Loss

The difference between the adjusted basis and the selling price of the property is what the seller must report as gain or loss. Gain is the excess of the amount realized from a sale over the adjusted basis of the property sold. Loss is the excess of the adjusted basis of the property over the amount realized from the sale.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. Original basis is usually the original purchase price of a property, unless the property was: a. inherited

b. a gift

c. acquired in exchange for services rendered

d. all of the above

2. Selling expenses and fixing-up expenses are the same thing and neither is deductible from the sales price of residential property. a. True

b. False

3. When a property is sold, the seller must calculate the gain or loss to determine the tax implications. a. True

b. False

The Sale of a Principal Residence

As you read, think about:

• What happens to the gain realized on the sale of a personal residence • The requirements to exclude up to $250,000 ($500,000 if married filing or joint tax return)

Exclusion of Gain

Under Internal Revenue Code Section 121, individuals are permitted to exclude from income up to $250,000 ($500,000, in general, if married filing or joint tax return) realized on the sale or exchange of their principal residence. Generally, a homeowner cannot use this exemption more than every two years. In order to qualify, the homeowner must have owned and used the property as his or her principal residence for at least two years during the five-year period ending on the date of the sale or exchange. In addition, the two-year period does not have to be continuous.

IRC Section 1034 which provided for a delay in the recognition of gain when purchasing a replacement residence of equal or greater value, as well as for the one-time exclusion of $125,000 of gain from the sale of a principal residence by someone age 55 years or older, was repealed by the Taxpayer Relief Act of 1997.

Married Couples

The $500,000 exclusion applies to married couples filing jointly when all of the following conditions are met:

1. Either spouse meets the ownership requirement; 2. Both spouses meet the use requirement; and 3. Neither spouse has had a sale of their principal residence in the preceding two years subject to the exclusion. (Even though one spouse has used the exclusion within two years prior to marriage, the other spouse would still be allowed a $250,000 exclusion.)

Pro Rata Exclusions

If the homeowner fails to meet the two-year requirement, he or she would still be entitled to a pro rata amount of the exclusion as long as the failure to meet the requirement is because the sale or exchange is by reason of a change in place of employment, health or other unforeseen circumstances. IRC Code Section 121 provides that this ratio is that portion of the $250,000/$500,000 exclusion equal to the fraction of the two years that the ownership and use requirement is met. Therefore, an unmarried taxpayer selling his or her property for an approved reason after only owning and residing in it for one year may exclude up to $125,000 of gain. Treasury regulations provide clarifications and safe harbors for the exemptions from the two-year period if the sale or exchange is by reason of a change in employment, health, or unforeseen circumstances. The regulations provide the following guidelines and safe harbors.

Place of Employment

Generally, a sale or exchange is deemed to be a change in employment if the primary reason for sale or exchange is a change in the location of a qualified individual's place of employment at least 50 miles further from the residence sold or exchanged than was the former place of employment.

Health

A sale or exchange is by reason of health if the primary reason for the sale or exchange is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury. A sale or exchange that is merely beneficial to the general health or well-being of the individual is not a sale or exchange by reason of health.

Unforeseen Circumstances

A sale or exchange is by reason of unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer does not anticipate before purchasing and occupying the residence. The regulations provide a safe harbor for any of the following events occurring during the taxpayer's ownership and use of the residence as the taxpayer's principal residence:

1. The involuntary conversion of the residence; 2. Natural or man-made disasters or acts of war or terrorism resulting in casualty to the residence; 3. In the case of a qualified individual's (a) death; (b) cessation of employment as a result of which the individual is eligible for unemployment compensation; (c) change in employment or self-employment that results in the taxpayer's inability to pay housing costs and reasonable basic living expenses for the taxpayer's household; (d) divorce or legal separation under decree of divorce or separate maintenance; (e) multiple births resulting from the same pregnancy; or 4. An event determined by the Commissioner to be an unforeseen circumstance to the extent provided in published guidance of general applicability or in a ruling directed to a specific taxpayer.

A "qualified individual" is defined in the regulations as the taxpayer, the taxpayer's spouse, a co-owner of the residence, or a person whose principal place of abode is in the same household as the taxpayer.

Gains Over $250,000/$500,000 If the homeowner realizes gains over the $250,000/$500,000 exclusion, the gains will be taxed at the more favorable capital gains rates. The maximum capital gains rates for property held more than one year is 15%. For those in the lowest tax bracket, the rate is 5%.

Other Special Rules

• Certain periods an individual resides in a nursing home on account of physical or mental incapacity are included as part of the two-year use requirement if certain other rules apply. • An individual whose spouse is deceased on the date of the sale of the property can include the period the deceased spouse owned and used the property before death. • An individual is treated as using the property as his or her principal residence during any period of ownership while the individual's spouse or former spouse is granted use of the property under a divorce or separation instrument. • Military personnel can suspend the five-year period for ownership and use test up to ten years when on qualifying extended military duty.

Installment Sales

As you read, think about:

• Advantages of the installment method of reporting gain • The three steps of the installment method

Introduction

An installment sale is a transaction in which a taxpayer sells his property but does not receive some or all of the payments for the sale until some time in the future. Usually, when seller financing is used, the transaction is an installment sale. The installment method is a special method of reporting gains from sales of property where at least one payment is received in a tax year after the year of the sale. Under the installment method, gain is prorated and recognized over the years in which payments are received. Installment reporting is permitted, regardless of the amount of payments to be received in the year, even if the entire purchase price will be received in one sum in a year subsequent to the year of the sale year. There is no minimum or maximum amount of payment required initially or to be received in the year of the sale.

Advantages of the Installment Method

The installment method of reporting taxable gain has a number of advantages over reporting the entire gain in the year of the sale:

• The seller will only need to use a pro rata share of the down payment received from the buyer to pay the tax due in the year of the sale. The seller can use a greater proportion of the down payment for his or her own purposes. • The seller is permitted to postpone tax payment on parts of the gain until the years he or she receives payments which include that proportionate share of the gain. • As a result of the progressive tax rate structure, the seller's gain may be taxed at a lower rate if reported over a period of years than if it is reported all in one year. • The seller may pay less tax by using the installment method. This advantage is most apparent if the spreading of the gain over more than one year will result in taxing it at a lower marginal tax rate.

Reporting Gain on the Installment Method

Installment method reporting involves three steps:

1. the seller computes the total gain which would be realized on the sale, assuming all required payments are made (the "gross profit"); 2. the seller determines the ratio of gross profit to the total payments required to be made to the seller under the sales contract (the total "contract price"); and 3. the seller multiplies each payment received on the contract price in any year by this ratio (the "gross profit reporting ratio").

The result is the amount of gain taxable in that year. Gain is proportioned to each future installment payment. If you are working with a seller or buyer interested in doing an installment sale, be sure to have them seek the advice of a tax expert.

Summary

This chapter covered the most basic aspects of taxation associated with the ownership of a principal residence. As the tax implications are usually considered by home buyers and home sellers, real estate licensees should have a general understanding of the potential tax results inherent in residential transactions. The most basic tax aspect covered in this chapter is property assessment (and reassessment) for the purpose of real property taxation. In addition to discussing when real property is assessed and how the amount of property tax is determined, we also looked briefly at the propositions and legislation that has an impact on the taxation of real property. We defined what qualifies as an owner's principal residence and discussed the necessity of determining whether or not a property is, in fact, the owner's principal residence. You learned that most expenses associated with owning a personal residence are not deductible. You also learned how to calculate the gain or loss on the sale of an owner's principal residence. We covered rules for homeowners aged 55 and older. We examined the rules for excluding $250,000/$500,000 in gain from the sale of a principal residence. Finally, we explained the installment method for reporting gain and described some of the advantages of using this method. Buyers and sellers who have tax-related questions should seek the advice of their attorney or Certified Public Accountant (CPA). However, it is still a good idea for real estate licensees to have a general understanding of the tax implications of the sale or purchase of a principal residence.

Self-Check Questions Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. In order for gain to be excluded from taxable income, the taxpayer is given a period of ______(either before or after the sale of the old principal residence), in which to buy and use a new principal residence. a. one year

b. two years

c. three years

d. four years

2. The exclusion from taxable income of gain realized from the sale of a principal residence is available only once in a lifetime. a. True

b. False

Appendix

Commonly Asked Questions About Taxation

1. Q: If a newly married husband and wife sell their two old residences and replace them with a single residence, will they still qualify for the $500,000 exclusion of gain on each old house? A: No, each spouse will qualify for a $250,000 exclusion on his/her old home. This represents the maximum exclusion each spouse would qualify for if not married. 2. Q: What is the basic rule of Proposition 60 as implemented by Assembly Bill 60? A: Ordinarily, when the ownership of California real property changes, the property is reassessed at its current fair market value and the new owner pays property tax based on the reassessment. Proposition 60 created an exemption to this general rule by providing that a taxpayer who is 55 years of age or older may transfer the Proposition 13 base-year assessment value of his or her principal residence to any replacement dwelling of equal or lesser value within the same county. In other words, if eligible, the homeowner will pay property tax on the replacement home based on the same assessment value as the former home. 3. Q: Are stepchildren, sons- or daughters-in-law, and adopted children eligible for the exemption under Proposition 58? A: Proposition 58 provides that if parents transfer any type of real property to their children, the transfer does not constitute a change in ownership and does not trigger reappraisal of the property for property tax purposes. For the purposes of this exemption, "children" of a transferor include: 1) any natural child of the transferor, except a child who has been adopted by other persons; 2) any stepchild of the transferor, and the spouse of that stepchild, while the relationship of stepparent and stepchild exists; 3) any son-in-law or daughter- in-law of the transferor, while the relationship of parent and son-in-law or daughter-in-law exists; and 4) any child adopted by the transferor, if the child is adopted before reaching the age of 18 years. 4. Q: How is the seller's profit or gain taxed if part of the purchase price involves seller financing? A: Seller financing of real estate generally qualifies for "installment sale" treatment under federal and California tax law. This means that profit or gain will be divided up and taxed over the number of years that payments are received on the financing, unless the seller elects to have the profit or gain all taxed in the year of sale. This favorable tax treatment is an incentive for using seller financing.

Exhibits for This Chapter

Exhibit 3.1. Property Tax Payment Dates

Important Dates to Remember

February 1st Second installment of taxes due

March 1st Assessment date for taxes

March 1st Taxes on unsecured roll due

April 10th Second installment of taxes delinquent date**

April 15th Last day to file homeowners', veterans' and senior citizens' exemptions

June 8th Publication date for delinquent taxes

July 1st Beginning of fiscal year

July 1st Owners to be informed of new values

July 1st Tax default***

Mid-September Tax rates set

Late October Tax bills mailed November 1st First installment of taxes due

December 10th First installment of taxes delinquent*

* Add 10% penalty ** Add 10% penalty + $10 penalty *** Add 10% penalty + $10 penalty + 1 1/2% per month penalty

Exhibit 3.2. Transfer Tax Exhibit

Transfer Tax Update (Current as of September 1, 2003)

Cities with Separate Transfer Taxes (in addition to county tax)

City Transfer Tax Rate Per $1,000 of Sales Price

Alameda $ 5.40

Albany $ 11.50

Berkeley $ 15.00

Cloverdale $ 1.10

Cotati $ 1.90

Culver City $ 4.50

El Cerrito $ 7.00

Hayward $ 4.50

Los Angeles $ 4.50

Mountain View $ 3.30

Oakland $ 15.00

Palo Alto $ 3.30

Petaluma $ 2.00

Piedmont $ 13.00 Pinole $ 5.50

Pomona $ 2.20

Redondo Beach $ 2.20

Richmond $ 7.00

Riverside $ 1.10

Rohnert Park $ 1.10

Sacramento $ 2.75

San Francisco $5.00 for values up to $250,000 $6.80 for values $250,000 to $1 million $7.50 for values over $1 million

San Jose $ 3.30

San Leandro $ 6.00

San Mateo $ 5.00

San Pablo $ 7.00

San Rafael $ 2.00

Santa Monica $ 3.00

Santa Rosa $ 2.00

Sebastopol $ 2.00

Stockton $ 3.00

Vallejo $ 3.30

Woodland $ 1.10

Winters $ 2.20

Windsor $ 1.10 Updated information on California City Property Transfer Tax Rates can be found at: www.californiacityfinance.com

Valuation of Residential Property

One of the most important factors for success in real estate is the ability to obtain listings that are priced properly for the market. When you accept a listing, as a real estate licensee you are obligated to put forth your best efforts to find a buyer for the property. This can only be done if the property owner sets an asking or listing price that will attract buyers. The basis for pricing properties appropriately for the market is an understanding of the theories of property valuation and in-depth knowledge of the market in which you work. In other words, real estate licensees need to be familiar with the concepts of value and the forces that influence value if they are to be successful at selling their listings. In addition, real estate agents must have a working understanding of the methods by which values can be estimated and be able to answer specific questions from sellers and buyers about value and fair price. The most useful tool for discussing price with sellers and answering questions about the market value of their property is the competitive market analysis form. This chapter discusses theories of valuation and how to complete a competitive market analysis.

Objectives

After studying this chapter, you will be able to:

• Define competitive market analysis • Identify situations which may require an appraisal • Differentiate between the different types of value • Explain the ten principles of appraisal • Identify data required for an accurate competitive market analysis • Estimate the most beneficial listing price for a property

Key Terms/Concepts

The following are the key terms and concepts found in this chapter:

• Competitive market analysis • Principle of • Most beneficial listing price • Principle of contribution • Appraisal • Principle of anticipation • Value • Principle of competition • Market value • Sales comparison approach • Principle of substitution • Cost approach • Principle of supply and demand • Income approach • Principle of change • Active listings • Principle of progression • Expired listings • Principle of regression • Comparable sales • Principle of conformity • Adjustments

An Introduction to Value

As you read, think about:

• The difference between an appraisal and a competitive market analysis • Different types of value • The ten basic principles of valuation • The three approaches to value used in appraisals

What Is a Competitive Market Analysis?

The best tool for helping sellers to list their property at a price that reflects fair market value is the Competitive Market Analysis (CMA). A CMA is an analysis which is done to determine the most beneficial listing price for a home. The most beneficial listing price is the price that will produce a sale at the highest sales price that will net the seller the most money possible, with the least amount of inconvenience, and within a reasonable time. A licensee's estimate of the most beneficial listing price should be based on a properly researched CMA, which should enable the licensee to present a clear and accurate picture of the real estate market to the seller. A CMA shows the seller what buyers have recently paid in the market, what they will have to pay today, and what they are not willing to pay.

What Licensees Need to Know About the Theories of Appraisal and Value

A CMA is not intended to be a substitute for an appraisal. Although both a CMA and an appraisal are estimates of value, it is not the licensee's objective to give the seller an appraisal of the property. Instead, the licensee is using the CMA to help the seller come to his own conclusion as to the value of the property and to set a price that will make the property competitive in the market.

An appraisal is a supportable and defensible estimate or opinion of value. Value is the present worth of future benefits to typical users or investors arising out of the ownership of property. An appraisal most often estimates market value. Generally, when someone is referring to the value of property, they mean the market value. This is the price for which a property will sell in the open market if the seller is not under any extreme pressure to sell, and the buyer is not under any extreme pressure to buy.

An understanding of the basic principles of value is important for an accurate pricing of properties. The principles described below provide the foundation for a professional analysis and value estimate of residential property. For real estate agents to be able to price properties effectively, they must understand the following ten principles of appraisal and communicate them clearly to the potential seller.

The Ten Principles of Appraisal

1. Principle of Substitution: A buyer will pay no more than the cost of a reasonable substitute of equal utility. 2. Principle of Supply and Demand: The greater the supply of an item, the lower will be its value; demand is created by scarcity, desirability, and purchasing power. 3. Principle of Change: Trends in economic, physical, governmental, and social forces brought about by change in those forces may affect property values. 4. Principle of Progression: The value of a less expensive property tends to increase by association, when placed among more valuable properties in the same area. 5. Principle of Regression: The value of a more expensive property tends to reduce by association, when placed among less valuable properties in the same area. 6. Principle of Conformity: Value is maximized when a reasonable degree of sociological, architectural, and economic similarity exists. 7. Principle of Highest and Best Use: The reasonable and probable use that supports the highest present value. 8. Principle of Contribution: Value of a component part of a property depends upon its contribution to the value of the whole. 9. Principle of Anticipation: Value depends on anticipated future benefits. 10. Principle of Competition: An individual listed property is in competition with other properties in its neighborhood and nearby communities.

The Three Approaches to Value

There are three accepted ways to approach the valuation of property: 1) direct sales comparison approach, 2) cost approach, and 3) income approach. The direct sales comparison approach is the method that a licensee would use to do a competitive market analysis for residential property.

Direct Sales Comparison Approach

The direct sales comparison approach to value is the most commonly used of the three approaches. The licensee finds comparables, which are properties very similar to the one for which he is trying to estimate value. By comparing the selling prices of comparables that have sold recently, the licensee can arrive at a valid estimate of value for the property. Comparables that were placed on the market but did not sell are used as indicators of the uppermost limit of value.

The direct sales comparison approach lends itself to properties that exhibit a high degree of similarity, and for which a ready market exists; it is particularly applicable to single-family residences. The direct sales comparison approach is the easiest of the three methods to learn and to use, and is the method most easily explained to sellers. Cost Approach

The cost approach to value is relatively simple in principle. This method is sometimes referred to as the reproduction-cost approach or the replacement-cost approach. The cost approach is an estimate of the amount of money that it would take to duplicate a property. People normally will not pay more for a property than it would cost to replace the property; therefore, the cost approach tends to set the upper limit of value. With the cost approach, the value of the land is estimated separately from the replacement cost of the improvements.

The replacement cost is how much it would cost today to construct an identical building, using the same materials and equipment that make up the property. An inventory of the materials would be taken, and then current prices of similar materials, equipment, labor costs and overhead to construct a replacement of the property would be applied. Existing depreciation of the property must also be considered when using the cost approach. This amount must be deducted from the replacement cost to determine the value of the building. The older the building, the more difficult it is to correctly estimate depreciation. A value of an older building determined by using the cost approach is only as reliable as is the estimate of depreciation.

The cost approach is appropriate for appraising newly built properties, where there is virtually no depreciation. It is also a good method for public properties that have no active market and, therefore, market data is not available for comparables. It is also suitable for properties which produce no income, such as government buildings, churches, recreational buildings, or extremely unique buildings with few or no comparables.

Income Approach

The income approach to value is important for the valuation of income- producing properties. Value is measured by the net income expected to be produced by the property during its remaining economic life. In other words, the income approach is concerned with the present worth of future income of property.

Three steps are involved in the income approach. First, an annual net income is derived by deducting total expenses from the gross income of the property. Second, a selection is made of an appropriate . The rate selected depends on the return investors demand before they will be attracted to a property. Third, the capitalization rate selected is applied against the net income to arrive at a figure that represents the appraised value of the property.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. The principle of ______states that value is maximized when a reasonable degree of architectural and economic similarity exists. a. substitution

b. progression

c. contribution

d. conformity

2. Which approach to value is the most commonly used by real estate licensees for the pricing of a property? a. direct sales comparison approach

b. cost approach

c. replacement approach

d. income approach

3. "CMA" usually refers to: a. competitive market analysis

b. certified master appraiser

c. comparative means analysis

d. comparative management appraisal

4. The most beneficial listing price for a home is the price that will produce a sale at the highest sales price, with the least amount of inconvenience, and within a reasonable amount of time. a. True

b. False

5. An appraisal is a supportable and defensible estimate or opinion of value. a. True

b. False

6. The cost approach is the most commonly used of the three approaches to value. a. True

b. False

Preparing for the Competitive Market Analysis

As you read, think about:

• How to set the right price in a listing agreement • The seller's three primary goals

Define the Problem

Remember, the primary goal of a listing agent is to obtain a listing agreement from the seller at the right price. The initial listing price is crucial to meeting both the seller's goals and the agent's goals. How can a licensee convince the seller of the right listing price and do it in a way that will result in a signature on the listing agreement? The licensee can meet these goals by analyzing the actions of buyers and sellers in the current market as they relate to and give indications of the value of the subject property.

Anticipating the seller's goals and objectives is crucial to meeting your goal as the listing agent. When making a listing presentation, it is important that a licensee approaches the presentation with an emphasis on the seller's three primary goals:

1. Highest net proceeds possible. Generally, this is the seller's primary or initial consideration. The potential seller's primary question when calling on your expertise is "What is my house worth?" Your listing presentation must convince the seller that you are an expert when it comes to understanding value. 2. Least amount of inconvenience. The seller must be made aware of the inconvenience that the listing and escrow periods may bring. The initial listing price of the property is the key factor of how inconvenient the listing period will be. 3. Reasonable marketing time. The marketing time relates to both of the first two goals. A long marketing time is inconvenient, and a good possibility exists it will hinder the highest net proceeds.

Plan the Competitive Market Analysis

Develop a systematic way of making your listing presentation and completing your competitive market analyses. For example, every time you have a listing presentation, you may want to proceed as follows:

1. Do your research: Before making your presentation, get enough basic information from the seller so that you can research comparable information ahead of time. 2. Inspect the subject property: Tour the inside and outside of similar listings and the outside of comparable sales; gather additional facts from the seller if needed; take photos of the subject property and of comparable sales; measure the subject property for square footage. 3. Prepare and analyze the CMA for the listing presentation: Complete the CMA form; attach data sheets, photographs, miscellaneous forms, etc. 4. Present to the seller: Make your listing presentation to the seller; clearly explain the CMA to the seller, going over how you arrived at your suggested listing price.

Completing the Competitive Market Analysis

As you read, think about:

• The kind of data to be collected for a CMA • How to complete a CMA form • How to analyze the data on the CMA form • How to make adjustments to comparables

Collecting the Data

As you sift through information about the subject property, its neighborhood, and the general marketing area, your primary focus should be on any non-typical beneficial or detrimental conditions. These conditions will have a great impact on the reliability of your value estimate. It's important to realize that sellers will always tell you about beneficial features, but they tend to overlook the detriments to the property or the neighborhood. Detriments to the property or neighborhood need to be appropriately considered and analyzed to arrive at the most beneficial listing price.

Listed below is the type of information you will need to research in order to complete an accurate competitive market analysis. The information you will need to collect has been divided into five categories: subject property data, site information, improvement information, general market data, and specific market data.

Subject property data consists of legal information, such as proper identification of the subject property, condition of loans, title, etc.

Site information consists of size and usable site utility, zoning and zoning compliance, waste disposal, sewer, septic, etc.

Improvement information consists of living area, rooms, amenities, information on permits, quality of construction, condition, compatibility, curb appeal, etc.

General market data consists of region/city data, neighborhood data and general market/economic conditions of the neighborhood, etc.

Specific market data consists of expired listings to set the outer limits of value, active listings to set the upper limits of value, and comparable sales to identify the estimated value of the subject.

• Expired Listings are properties which have not sold. They are properties that have been taken off the market or expired; these properties represent what buyers are not willing to pay. They show what will probably happen if a seller sets his listing price too high for the market. • Active listings are properties which are currently being offered for sale. These properties are the competition for the subject property; they represent the sale price sellers want to get for their property. Active listings indicate the upper limits of value for the property. • Comparable sales are properties which have recently sold. They represent the price buyers have been willing to pay for similar properties. If the conditions and characteristics of the comparable sales and the subject property are similar, then these sales probably represent the lower limits of value. Comparable sales may be the most important information in your CMA.

The CMA Form

The CMA form itself is fairly easy to complete once you have done your research. The form usually has three main sections and a place for general comments and miscellaneous information, including the probable marketing range conclusions.

Properties Currently Offered for Sale

The first section of the form is for active listings. This section contains information about properties currently being offered for sale and shows the asking prices of the competition. These present prices represent the upper range of value for the subject property. Remember, however, the upper range of value is not the same as market value.

In this section, there is a place for you to include basic information about the property, such as addresses of the property listed for sale, number of bedrooms and baths, family room or den, square footage and any other items of importance.

Space is also provided to describe the existing financing. This is where you will include information on first and second loans, reported balances due, interest rates and types of loans.

The current listing prices and the number of days the properties have been on the market should also be listed on the form. How long a property has been on the market is helpful in determining how realistic the asking price is. If a property has been on the market for a longer time than others, it may very likely be overpriced.

The last information to be listed on the first section is any proposed new financing. Any seller financing would be noted here.

Properties Recently Sold

The next main section of most CMA forms is for comparable sales. This section is for properties that have recently sold and closed escrow. The information provided in the first section, such as address and characteristics, should also be provided for these properties. In addition, space is provided for sales prices, financing, date sold, and other terms and comments. As stated before, recent sales of comparable properties set the lower range of value and are usually the most reliable indicators of market value and thus the most important part of the form. Of course, to be truly comparable to the subject property, the value of the comparable sales and the terms and conditions under which they were marketed must truly be similar. That is why the most current information available is the best. What buyers were willing to pay as recently as six months ago may not be what buyers are willing to pay today.

The CMA form allows for seven comparable properties. The more comparables provided, the more reliable the listing price estimate will be. If information on more than seven recent sales is available, simply present it on a supplemental sheet.

Properties That Did Not Sell

The third main section is for expired listings. This section lists properties that were for sale that either failed to sell or were taken off the market for another reason. The information on each property (such as address and characteristics) that was listed in Sections One and Two should also be listed here.

Properties reported as expired listings on the CMA represent properties similar to the prospective seller's property that the market has rejected. Most likely, the listed prices for these properties were at levels above what buyers were willing to pay; therefore, it would make sense that the subject property should probably be listed below that level.

General Comments

The final sections on most CMA forms are for any other information the licensee feels is important to include. General comments, such as market conditions, subject property benefits and detriments, recommended terms of sale, etc., should be made in this section.

Conclusions

At the bottom of most CMA forms is a place for indicating the "probable marketing range." The licensee should make this determination only after analyzing all of the information listed on the rest of the CMA form. The licensee must consider not only the prices of comparables, but also the terms of the sale, the market conditions, and the physical characteristics of the comparable properties.

Analyzing the Data on the CMA Form

As a professional, you will need to systematically and thoroughly analyze all the above data needed to complete the CMA. The direct sales comparison approach to value is the foundation of the CMA, and provides the information from which the most beneficial listing price can be suggested to the owner. Data should be obtained from all of the following comparables: expireds, listings, pendings, and sales. All of a licensee's available data sources should be used. With competitive market analyses, the more data the better. The principle of substitution provides the basis for the direct sales comparison approach. In doing a competitive market analysis, it is necessary that the licensee thoroughly research the market for properties similar to the subject property. By similar, we mean that licensees should find properties that are similar as to conditions of sale, market conditions, location, and physical characteristics, such as size and age.

Conditions of Sale

One area to look at when considering the conditions of the sale of comparables is the terms of financing. Was there seller financing involved? Was there no down payment, which might explain a higher price? Or perhaps it was an all-cash sale, which would explain a lower price. The licensee must be aware of these conditions in order to adjust the comparable to the cash equivalency of what the subject's most probable terms will be. Of course, if the financing arrangements did not affect the price paid for the comparable sale, no adjustments would be necessary.

The licensee should also look at the terms of the sale. The seller may have given something away that might have influenced the sale. Perhaps the seller made some concessions or included personal property. Such considerations can have an impact on the selling price of a property that otherwise appears to be similar to the subject property.

Market Conditions

When looking for comparables, it is important to consider the time of the sale and the location of similar properties. The market conditions of the past sale may not be similar to present conditions. Prices may have increased or decreased since the comparable property was sold. Financing or interest rates may also have changed. Obviously, the most recent sales are best. When looking at possible comparables, always ask yourself: If this comparable sale were on the market today, would it sell for the same price?

Physical Characteristics and Location

The following are considered to be physical characteristics and should be compared to those of the subject property: site, condition, design and appeal, quality of construction, age/effective age, room count, gross living area, functional utility, heating and cooling, garage/carport, pool/spa, patio, fireplace, appliances, and any other pertinent characteristics.

Location is also an important consideration. Properties located within the subject property's neighborhood should be considered for a difference in negative or positive influences. Properties located outside of the subject's neighborhood should be considered as superior or inferior to those inside the subject neighborhood.

The Adjustment Process

The most dependable value estimates are those where the factors and conditions of comparison are mostly similar. When dissimilarities between the subject property and the comparable exist, the real estate licensee must consider the extent of the dissimilarities and then estimate the amount that they add to or subtract from the sales price of the comparable property. When making adjustments, the subject property is the standard. All adjustments are made to the comparable sales. Remember, the licensee is looking for reasonable estimates when making adjustments to comparable sales.

Making the Adjustments

The following sequence should help in understanding how to make adjustments to comparables when completing the competitive market analysis. Adjustments should be made in terms of both dollar amounts and percentages.

1. List the most recent and most comparable property sales. When you come across a sale that is noticeably lower or higher than the rest, suspect that sale. 2. List in the adjustment grid the value-determining characteristics of the subject property. 3. Compare the sales property with the subject property in terms of pertinent characteristics: o conditions of sale o market conditions o location and physical characteristics. 4. Determine the adjusted sales price of the comparable property sales after adjustments. 5. Reconcile the comparable property sales into the most beneficial listing price for the subject property.

Summary

This chapter covered two of the factors which are essential for pricing properties properly: theories of valuation and a competitive market analysis. Understanding the principles of valuation will provide you with a foundation for completing your CMA's. We covered the ten principles (or theories) of valuation, including the principle of substitution, which is the most important theory behind the competitive market analysis. We discussed the different kinds of value and the three approaches to determining value. Of the three approaches to determine value (cost approach, income approach, and direct sales comparison approach), the direct sales comparison approach is used most frequently by real estate licensees involved in residential transactions. We looked in-depth at the process of completing a competitive market analysis, as the CMA is the most useful tool for discussing price prospective with sellers. You reviewed the contents of a typical CMA form and learned how to complete each section. By knowing the data that is required for an accurate CMA and being able to effectively estimate the most beneficial listing price for a property, you will be prepared to answer questions from buyers and sellers about the price and value of homes on the market.

Self-Check Questions Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. The principle of substitution provides the basis for the direct sales comparison approach. a. True

b. False

2. When completing a CMA, it is important to remember that expired listings represent the price buyers are not willing to pay for similar properties. a. True

b. False

3. Comparable sales represent the price buyers have been willing to pay for similar properties. a. True

b. False

Appendix

Commonly Asked Questions About Valuation of Property

1. Q: Must all California appraisers be licensed or certified? A: No, an appraiser must be licensed only when a "federally related transaction"

is involved. 2. Q: What is meant by the term "federally related transaction?" A: It means a real estate transaction in which the transaction involves 1) the sale, lease, purchase, investment in, exchange of, financing or refinancing of real property; or 2) the use of real property or interest in real property as security for a loan or investment, including loan-backed securities. Further, the funding source, such as a bank or savings and loan, is regulated by or has contracted with a federally financed institution and regulatory agency (e.g., Federal Reserve Board, Federal Deposit Insurance Corporation, etc.).

This effectively includes loans insured by the FHA, guaranteed by the VA, or intended for sale to FNMA, FHLMC, or GNMA. 3. Q: Are real estate licensees who perform appraisals regulated by the appraisal laws? A: Yes, when they are performing appraisals in a federally-related transaction. 4. Q: Does a real estate licensee need to be a licensed or certified appraiser to complete a comparative market analysis when a listing is taken? A: No. However, the licensee should clearly state that the CMA is not an appraisal, and it should still be prepared in a careful and competent manner. In other words, a real estate licensee can continue to complete competitive market analyses. 5. Q: Is the Department of Real Estate involved in the appraiser licensing and certification process? A: No, the Office of Real Estate Appraisers (OREA) has jurisdiction over the

licensing and certification of appraisers.

Escrow

Introduction

The escrow process is a vital part of almost every real estate transaction in California. Since escrow is one of the most important elements of a real property transaction, real estate agents should be clear about their role throughout this process. When a real estate licensee has a signed offer from a prospective buyer and an acceptance of the offer from the seller, she is ready to enter into escrow and close the transaction. However, it is not enough for real estate agents simply to help their buyers and sellers get to escrow, they must also help them through the escrow process. It is essential for real estate agents to have a good understanding of the escrow process if they want to see their transactions close.

Objectives

After studying this chapter, you will be able to:

• Recognize how the real estate agent fits into the escrow process • Explain to buyers and sellers how escrow works • Identify who can act as an escrow holder and recognize his or her duties • Follow the steps in the escrow process in Northern or Southern California • Help buyers and sellers to open escrow • Assist the escrow officer by providing all the necessary documents and information needed for a smooth escrow • Facilitate the close of escrow

Key Terms/Concepts

The following are the key terms and concepts found in this chapter:

• Escrow • ALTA Lender's Policy • Trust account • ALTA Residential Policy • Escrow agent • Promissory note • Beneficiary's statement • Deed of trust • Escrow instructions • Grant deed • Bilateral instructions • Regulation Z • Unilateral instructions • Right of Rescission Notice • Amendments to escrow • Statement of information • Title search • Bill of sale • Prelim • Funding package • Title insurance • Constructive notice • CLTA/ATLA Homeowner's Policy

The Basics of Escrow

As you read, think about:

• The definition of escrow • What constitutes a valid escrow

Not all states use escrow as we do in California, and for many buyers and sellers, the escrow process is a complete mystery. Unfortunately, escrow is even a mystery to many real estate licensees. The Merriam-Webster Dictionary defines escrow as "a deed, a bond, money, or a piece of property delivered to a third person to be delivered by him to the grantee only upon the fulfillment of a condition." What does this mean? In simple terms, escrow is a fair and unbiased way of enabling the transfer of ownership. Escrow involves an impartial third party (the escrow holder) who sees that the primary parties (the buyer and seller) perform as they agreed they would. The escrow holder is a neutral intermediary for the parties involved in the transaction, with the legal obligation to maintain the interests of everyone affected by the outcome.

Escrow provides a clearinghouse for funds and documents as well as a means for seeing that all the conditions of the real estate transaction are met before the property is transferred from the seller to the buyer. The escrow holder takes the deed from the seller and the purchase money from the buyer and holds them until all of the conditions of escrow have been met. All parties to the escrow have legal protection during the escrow period, and everything is administered by the neutral escrow holder, reducing the risk of any violations of the agreement.

To have a valid escrow, there must be a binding contract between the buyer and the seller, and transfer instruments must be delivered to a third party. Escrow is said to exist when a buyer of real property agrees through a valid written contract, usually a deposit receipt, to relinquish all control over his purchase money in exchange for the seller's grant deed. Escrow is a legal process and must, therefore, comply with contract law. The principals must comply with the contracts they have signed, and the escrow officer must comply with the escrow instructions. Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. To have a valid escrow, there must be a binding contract between the buyer and the seller. a. True

b. False

The Escrow Holder

As you read, think about:

• Who can hold an escrow • The duties of an escrow holder

Independent Escrow Agents

In order to assure that the escrow agent can be trusted to do her job competently, impartially, and legally, the California Commissioner of Corporations oversees the function of independent escrow agents. The Commissioner of Corporations imposes strict regulations on independent escrow agents and requires them to be licensed corporations.

The regulations under which independent escrow agents must operate are found in §§17000 - 17614 of the California Financial Code. The Financial Code defines an escrow agent as any person engaged in the business of receiving escrows for deposit or delivery. The Financial Code requires any corporation, partnership, firm, or individual who wants to engage in business as an escrow agent in California to be licensed. However, exemptions from the licensing requirements are granted to banks, savings and loan institutions, insurance companies, title insurance companies, real estate brokers, and attorneys.

Other Escrow Holders

In addition to independent escrow agents, others may conduct an escrow. Although escrow is normally conducted by independent escrow agents in Southern California, title companies usually conduct escrows in Northern California. Title company escrow departments are governed by the California Commissioner of Insurance.

An attorney may also serve as an escrow holder. However, he may do so only if it is incidental to the duty he is performing for his client as an attorney-at-law. Attorneys often conduct escrows for their clients in California, and as escrow agents, they are regulated by the California Bar Association. A real estate broker may conduct an escrow only if the escrow is directly connected to the transaction in which she is an agent for the buyer or seller. The California Real Estate Commissioner requires brokers who conduct escrow services to maintain escrow funds in a separate trust account. The records of deposits must be maintained in accordance with §§2950 and 2951 of the Commissioner's Regulations, and the account is subject to inspection by the Commissioner.

Duties of the Escrow Agent

The escrow agent serves as an impartial third party, keeping all information concerning the escrow confidential. The agent performs all of the clerical duties necessary to close the escrow, following the instructions from the parties in the transaction. The clerical duties are many and include:

• Ordering the preliminary title report • Obtaining title insurance for the buyer and the lender • Securing payoff demands/beneficiary statements from existing lenders • Requesting full reconveyances of any of trust to be paid off • Obtaining loan documents from the lender • Obtaining documents to clear any outstanding liens against the property • Issuing receipts for deposits of documents and funds • Holding funds in a separate trust account • Prorating taxes, interest, rent, and insurance • Preparing escrow instructions and seeing that all documents are properly executed • Determining when the transaction should be able to close • Recording the necessary documents after all of the conditions of the transaction have been met • Disbursing funds to the proper parties • Delivering documents and preparing the final closing statements

Choosing the Escrow and Title Insurance Companies

Which escrow company and/or title insurance company to use must be mutually decided by the buyer and the seller. In practice, however, the principals usually rely on the advice of their real estate agents. Agents should only provide guidance in the selection of the escrow and title insurance companies, and not insist on their own choice. Also, sometimes institutional lenders have their own escrow departments and insist on using them exclusively for their loans.

IMPORTANT NOTE: If a broker owns an escrow/title insurance company, the agent cannot suggest his broker's company without letting the buyer and seller know that the broker will profit from this choice.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. Who may open escrow? a. the seller only

b. the buyer only

c. the listing agent only

d. anyone designated in the purchase agreement by the buyer and seller

2. Which of the following is not a duty of the escrow agent? a. ordering the preliminary title report

b. obtaining loan documents from the lender

c. qualifying the buyer

d. disbursing funds to the proper parties

3. Who may serve as an escrow holder in California? a. an independent escrow agent

b. a title company

c. an attorney

d. all of the above

4. The escrow agent serves as an impartial third party, keeping all information concerning the escrow confidential. a. True

b. False

5. In Southern California, the entire escrow process is conducted through a title insurance company. a. True

b. False

The Escrow Process

As you read, think about:

• How escrow procedures differ between Northern and Southern California • Basic steps in the escrow process • How the real estate agent fits into the escrow process Escrow Procedures Are Not Uniform Throughout the State

Although the escrow process is basically the same throughout California, there are some differences between the North and South. The most significant differences are described in the chart below.

North South

Who Conducts The entire escrow procedure The escrow procedure usually Escrow? is conducted through a title starts at an escrow company, insurance company. continues back and forth between the escrow agent and the title insurance company, and closes with the escrow company.

How Is It is routine to open the It is standard to prepare the Escrow escrow by memo only and escrow instructions and obtain Opened? not have the principals sign the principals' signatures as the the escrow instructions and first step in opening escrow. other documents until escrow is ready to close.

How Are Separate instructions for A single instruction form signed Instructions buyers and sellers (unilateral by both buyers and sellers Drafted? instructions) are commonly (bilateral instructions) is usually used. used.

Steps in the Escrow Process

Although the steps are not always the same in each and every escrow, there is a general sequence which is the same for most transactions. Listed below are the steps in most Southern California escrows, followed by those for Northern California.

Southern California Escrows

1. Once the real estate agent obtains a completed deposit receipt signed by all parties to the transaction, he or she opens an escrow and prepares the escrow instructions using a standard form provided by the escrow holder. The RPA-CA is also joint escrow instructions. If this form is used, the escrow would only have to prepare supplemental escrow instructions. 2. All parties to the transaction sign the escrow instructions, and the escrow holder orders a title search from a title insurance company. 3. The escrow officer requests a Beneficiary's Statement from the beneficiary shown on the recorded deed of trust. The statement shows the condition of the indebtness and the unpaid balance of the loan. 4. The escrow officer reports to the buyer and/or seller matters revealed by the preliminary title report that were not approved in the escrow instructions. 5. When the escrow officer receives all the documents and funds necessary to close the escrow, he makes the necessary adjustments and prorations between the parties on a settlement sheet. 6. The necessary instruments are forwarded to the title insurance company with instructions to record them. 7. The title company runs a title search to date as of the close of business on the date set for close of escrow. If no change of title is found, the deed and other instruments are usually recorded on the following morning. 8. On the day of recordation, the escrow officer disburses funds to the parties entitled to them, transfers or amends fire insurance policies, and presents closing statements to the parties entitled to them. The title insurance company generally tries to issue the title insurance policy on the same day. 9. Within a few weeks, the county recorder's office will return the recorded deed to the escrow officer, who will forward it to the purchaser.

Northern California Escrows

In many ways, the steps in Northern California escrows resemble those in Southern California. The main distinction is that in Northern California it is the title company that issues the title insurance policy, takes care of recordation, and performs the escrow function.

1. The real estate agent opens an escrow at a title company after he has obtained a completed deposit receipt signed by all parties to the transaction. The broker will either deposit any money received from the purchaser as deposit into a trust account or deposit it with the title officer. 2. A preliminary title search will be prepared, and copies will be sent to the broker for the buyer and seller. 3. Matters disclosed by the preliminary title search are taken care of; the title officer will receive any instructions that may be necessary in addition to those agreed on in the deposit receipt. 4. The title officer requests a Beneficiary's Statement; this is a statement of the condition of indebtedness and balance of the loan from the beneficiary under the existing deed of trust. 5. When the title officer receives all the documents needed to close the escrow, he or she will make the necessary prorations and prepare the buyer's and seller's instructions. 6. The buyer and seller sign their respective instructions and any other documents that may be necessary. 7. The title officer requests and obtains all funds necessary to close. 8. The title search is run to date as of the close of business on the date set for close of escrow. If no change of title is found, the deed and other instruments are usually recorded on the following morning. 9. The title policy is issued and funds are disbursed to the parties entitled to them. Insurance endorsements are obtained and the policy and copies are sent to those entitled to them. 10. When the title officer receives the documents from the recorder's office, he or she forwards them to the parties to the transaction.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. Congress has mandated that all states use uniform escrow procedures. a. True

b. False

Opening Escrow

As you read, think about:

• How escrow is opened • How the deposit receipt relates to escrow • What information is needed to open escrow

Opening escrow is a simple process. Anyone involved in the transaction can open escrow: the buyer, seller, lender, selling agent, or listing agent. The only requirement is that the buyer and seller must have designated someone to do it when the purchase agreement was signed. To open escrow, the designee (usually the listing or selling agent) simply visits the office of a company that handles escrows, gives the escrow officer the purchaser's deposit monies, and provides information about the transaction. In Southern California, escrow agents usually request copies of all the contracts, inspection reports, and any other documents related to the transaction. Also in Southern California, usually the listing agent, selling agent, and lender all submit escrow instructions at the time escrow is opened.

The Deposit Receipt

The deposit receipt serves as the foundation for the escrow instructions. In Southern California, the escrow officer usually requests an actual copy of the deposit receipt; the RPA-CA (see Appendix, p. 166) is also joint escrow instructions. In the North, the deposit receipt is not usually submitted to the title company. Even if the title company prefers not to keep a copy of the deposit receipt form in the escrow file, the real estate agent should still bring a copy to open escrow. This will ensure that the escrow officer has the exact terms of the transaction to transfer to the escrow memo and, later, to the escrow instructions.

To open escrow, the escrow or title company will need all of the information regarding the transaction listed below in order to prepare the escrow instructions. The deposit receipt contains most of the following information necessary to start the escrow process:

• The purchase price • The deposit received from the buyer and instructions on what happens if the agreement is cancelled • Any personal property included in the sale • The date escrow is to close and what happens if closing is delayed • Any prorations and the date that will be used for computing them • The date when the buyer may take possession • The terms for the payment of commissions to real estate brokers • Information about the termite inspection and instructions for remedying any deficiencies disclosed in the termite inspection • Information about other property inspections • The legal description and street address of the property • The full names of the parties involved in the escrow, their addresses, and telephone numbers • The financing arrangements, including the names, addresses, and telephone numbers of all lienholders; all loan numbers; and the approximate unpaid balances • Terms of new encumbrances or existing encumbrances • If applicable, a rental statement with a list of tenants, rental amounts, and refundable deposits • Information as to how the buyer(s) wants to take title • Parties to whom preliminary title reports are to be sent • Fire insurance information

Prior to Closing Escrow

As you read, think about:

• Escrow instructions • What needs to happen in order for escrow to close • The title search and title insurance • What documents the buyer and seller will have to sign

Escrow Instructions

The escrow instructions are the written authorization from the buyers and sellers to the escrow or title company, and are drawn up by the escrow agent. The escrow agent takes the deposit receipt and other information from the opening file and writes up actual instructions detailing how the sale will take place. In order to be able to carry out the expectations of all the parties involved in the transaction to their mutual satisfaction, the escrow officer must be aware of all the facts of a purchase.

The escrow instructions specify all of the conditions that must be met prior to the close of escrow. They state which parties will pay for what costs, they authorize the escrow holder to disburse the monies to the proper parties, and they instruct the escrow holder to record the necessary documents in order to close escrow when the parties involved have met all of the terms specified. Most escrow and title companies have standard preprinted supplemental escrow instruction forms; however, there is no legal requirement governing the format for escrow instructions. Escrow instructions may be either unilateral or bilateral. With bilateral instructions, as used in Southern California, the buyer and seller sign the same set of instructions. The escrow instructions are generally drawn up and signed when escrow is first opened. In Northern California, unilateral instructions are used, whereby the buyer signs one set of instructions, and the seller signs another. In Northern California, the real estate agent plays a larger role in getting information to the title company and making sure that the escrow instructions are complied with. The instructions are normally drawn up after all the information is received and escrow is ready to close.

The escrow instructions should never contradict the agreements reached by the parties in the purchase agreement. The use of the RPA-CA reduces this possibility.

Escrow instructions should provide the escrow holder with the following specific information:

• The conditions that must be met prior to the close of escrow (e.g., loan funding) • The documents and monies to be deposited into escrow, and who will deposit them • A list of items to be prorated (e.g., property taxes) • An explanation of the fees to be paid by the buyer and the seller

Amendments to Escrow

An amendment to escrow is a change to escrow, without changing the principal idea or essence. An escrow might be amended to correct an error, to alter an agreement, or to add to part of an agreement. Amendments are written up by the escrow agent when new information or instructions are given to him or her. For example, if the actual date of an escrow closing will differ from the original date used for the computation of prorations, escrow must be amended.

Any amendments to the escrow instructions are usually the result of amendments to the original contract, agreed to by the principals. In other words, the escrow instructions can be modified by mutual consent of the buyer and seller.

The Title Search

Once escrow has been opened, a title search is ordered to trace the to the property back through every available record. The title search determines if the person claiming to be the current owner actually has legal ownership, and the right to sell the property. The search also reveals if any defects exist on the title. The results of the title search are compiled into a preliminary title report, frequently called a prelim. Title insurance companies will not issue a title insurance policy without a thorough title search, and a prelim indicates the conditions under which the title company would be willing to issue such a title policy.

The preliminary report compiled from the title search is usually among the first of the many escrow documents received by the escrow agent. The prelim reveals the following information: • The vested owner's name as it appears in public records • The exact legal description of the property • The estate or interest in the property • The vesting of the estate or interest • The status of the current real estate property taxes and the date of the last property assessment • Any outstanding liens, restrictions, easements, or other types of encumbrances • The conditions under which the title company will issue title insurance • A plat map showing the location and dimensions of the property as found in recorded documents

The above information, revealed in the prelim, lets the escrow officer know what items must be cleared up in order for the title to be conveyed from the seller to the buyer. The prelim is merely a report prepared prior to the issuance of a policy of title insurance and is not intended to be a guarantee or an insurance policy. It does list, however, in advance of completion of escrow, title defects, liens, and encumbrances that would be excluded from coverage if the title policy were to be issued as of the date of the report.

Title Insurance

The property a buyer intends to purchase does not always have a "clean" past; there may have been dishonest dealings, forgeries, or other problems. A buyer cannot be completely certain that the current or previous sellers actually held clear title to the property or had the right to legally transfer it at all. There may even be a defect or a cloud on the title that the owner does not know about. That is why title insurance is so important. Title insurance will protect a principal from claims out of the past. Institutional lenders require title insurance before releasing monies through escrow; if there is no institutional lender in the transaction, the real estate agent should recommend title insurance to his or her buyer. Either way, in order to provide the best service possible, you should be able to explain the concept of title insurance to your buyers and be familiar with the most common policies.

The protection provided by an owner's title insurance policy will continue until his or her interest is transferred. Even if an insured owner dies, his heirs will remain protected under the terms of the policy. However, a title insurance policy cannot be assigned or transferred to subsequent purchasers of the property. Each new buyer must purchase a completely new policy of title insurance, regardless of how recently a title search may have been conducted by a seller. The seller's policy is in favor of the buyer. The buyer's policy is in favor of the lender.

Four standardized title policies are usually used by property owners. They are the CLTA Standard Coverage policy, the ALTA Residential policy, the ALTA Owner's policy and the CLTA/ALTA Homeowner's policy. The CLTA policy provides less coverage for off-record risks than the ALTA Owner's or ALTA Residential policies. Traditionally, the CLTA policy costs less than an ALTA Residential policy but in many geographic areas competition has resulted in the ALTA Residential policy being offered at a price equal to, or not significantly higher than, the CLTA policy. The CLTA/ALTA Homeowner's policy offers more coverage than the standard CLTA and ALTA Residential policies and is the policy required by the pre-printed terms of the RPA-CA. CLTA

The California Land Title Association (CLTA) was established in 1907 to provide standardized forms for title insurance policies and endorsements. A uniform version of the CLTA Standard Coverage title insurance policy is available throughout California and insures the ownership of the estate or interest in the land described. The CLTA policy also insures against loss or damage that the insured may sustain because of unmarketability of title. The CLTA policy contains standard exceptions for contingencies that could not be determined in searching and examining the public records but that could be detected by inspecting or surveying the land. Risks, such as encroachments, unrecorded easements, conflicts in boundary lines, and interests of parties in possession of the land, are generally considered to be reasonable for an owner or lender who is familiar with the property. The industry has been able to keep its CLTA Standard Coverage premiums at a low rate by excluding these risks from its coverage.

ALTA

The American Land Title Association (ALTA) is a nationwide trade organization that provides insurance "above and beyond" that provided by the CLTA Standard Coverage policy. The ALTA lender policy provides most of the additional coverage that lenders throughout the nation require, and its language is stronger than that of the CLTA policy. Also, unlike the CLTA Standard Coverage policy, which allows joint protection for both lender and owner, a lender that requests ALTA coverage will get a separate policy insuring its trust deed only.

CLTA Standard Coverage and ALTA Residential

The CLTA Standard Coverage policy can be purchased for any type of property. The ALTA Residential policy can only be bought for residential property dwellings containing no more than four units, or condominiums.

The CLTA policy does not provide coverage for easements, liens and encumbrances not shown by public records, the unrecorded rights of a person in possession, or matters which would be disclosed by a survey. The ALTA Residential policy also does not cover these items. Furthermore, the ALTA Residential policy specifically provides coverage for: mechanics' liens for labor and material furnished prior to the policy date (unless the insured agreed to pay); easements; forced removal of an encroachment (other than a boundary wall or fence); and use of the property as a single-family residence under zoning laws.

The coverage provided by an ALTA Residential policy is more extensive than the CLTA Standard Coverage policy. In a particular transaction, the parties must decide whether increased coverage provided by an ALTA Residential policy is worth the increased premium, if any.

CLTA/ALTA Homeowner's Policy

The CLTA/ALTA Homeowner's policy is required by the preprinted language in the RPA-CA because there are significant coverage benefits for the buyer. First, the ALTA-R (Alta Residential) policy is often issued with "Western Regional Exceptions." These exceptions somewhat reflect the exceptions in the CLTA Standard Coverage policy and, as a result, many of the off-record protections on the ALTA basic policy are deleted. On the other hand, the ALTA Residential Enhanced and the CLTA Homeowner's policies do not have standard exceptions to off-record matters.

Second, the CLTA/ALTA Homeowner's policy provides coverages which are not afforded by the ALTA-R policy. These additional coverages include: removal of structure for building permit, Subdivision Map Act or restrictive covenant violations, enhanced access, post-policy forgery and encroachment, automatic policy increases, and extension of coverage after an estate planning trust transfer. Some coverages, such as structure removal, are subject to a deductible and liability cap for the insurer. The CLTA/ALTA Homeowner's policy, like the ALTA-R, is only available for residential properties with one-to-four dwelling units.

ALTA Owner's Policy

The CLTA Standard Coverage policy is available for all types of property. While the ALTA Owner's policy is available for any residential or commercial property, it is generally only used for multi-family or commercial properties.

The ALTA Owner's policy is more extensive than the CLTA policy. If the extended coverage version of the ALTA Owner's policy is issued, it will not contain the preprinted exceptions from coverage contained in the CLTA Standard Coverage policy.

Because of the more encompassing coverage in the standard language of an ALTA Owner's policy, a survey is typically conducted to discover defects in title.

The Buyer's Down Payment - The Down Payment is usually in reference to the entire amount required to close.

The escrow officer will determine the exact amount the buyer has to pay as a down payment. Approximately three days before escrow is scheduled to close, the buyer must deliver the total down payment to the escrow officer (Southern California) or title insurance company (Northern California).

The Final Inspection of the Property

Often, buyers will request a walk-through, or final inspection of the property, before authorizing the escrow officer to close escrow. If the buyer wants to request this final walk-through, the real estate agent should make sure this is indicated in the deposit receipt.

Reviewing and Signing the Documents

Once the title search has been conducted, the loan has been approved, the termite clearance has been received, the escrow agent has written the escrow instructions, and all the documents have been drawn up, escrow is finally ready to close. At this point, the principals will go to the escrow office to sign the instructions (Northern California) and all of the documents necessary for the transfer. In Southern California, only the buyers usually go to escrow.

It is important to note that once buyers and sellers have signed their set of escrow documents, they may be subject to penalties or legal action if they try to cancel escrow for any reason. For this reason, the agents and the principals should all receive copies of the documents at least one day before the signing to review. All principals in the transaction should read the documents carefully, being certain that they can abide by the agreements they are going to sign. The real estate agents must be able to either answer their principals' questions or know where to find the answers to any questions that may arise. It is important that the principals understand the intent of each of the documents they are signing; they will rely on their agents to guide them through this stage of the transaction.

There are certain papers that must always be signed by the buyer; however, there are others that vary according to the lender's requirements and the type of loan the buyer has arranged. The buyer will always sign an original promissory note and an original deed of trust. Among the documents usually included in the transfer of property are:

Original Promissory Note: A promissory note is the buyer's promise to pay, and should be read over carefully before the buyer signs it. The loan amount, interest rate, monthly payment, and due date should all be verified.

Deed of Trust: The deed of trust is the instrument that secures the debt. It, too, should be read carefully, with all terms being verified by the buyer.

Grant Deed: The grant deed is the most common instrument used in the transfer of real property in California and is signed by all the principals. The seller (grantor) transfers title to the buyer (grantee).

Regulation Z Statement: The buyer will usually be given an estimated statement of loan fees and closing costs. This statement is called a Regulation Z or Federal Truth-in-Lending Statement. The statement gives the buyer a breakdown of all the loan items he will be charged for, including the total amount the buyer will be paying over the life of the loan.

Right of Rescission Notice: This document allows certain buyers a last opportunity to cancel the loan within three working days of its receipt. Customarily, the buyer will sign this notice twice--the first time, when signing the loan documents, and then again, at the end of the three-day period.

Fire Insurance Form: The buyer may have to sign a statement agreeing to comply with the lender's requirements for fire insurance. The lender will specify the kind of insurance and how much coverage is required.

Lender's Escrow Instructions: The lender's instructions to the escrow company state the conditions that must be met before the deed of trust can be recorded. The buyer will sign a copy of this statement to show that he has read it, understands it, and agrees with its terms and conditions. Statement of Information: Title insurance companies normally require a Statement of Information on all individual grantors, grantees, and borrowers. This statement provides pertinent data on individuals and guards against forgeries. These statements also help title companies eliminate items such as judgments and bankruptcies against persons with similar names.

Bill of Sale: When the seller includes personal property, such as a refrigerator or stove, as part of the deal, the buyer should obtain a bill of sale signed by the seller. The bill of sale should state which items the seller agrees will be part of the property sale in order to prevent any possible confusion over what stays with the property and what goes with the seller.

Self-Check Questions

Answer the following questions to test your understanding of the information addressed in this chapter. If you answer any questions incorrectly, go back and review the relevant sections of the chapter.

1. Escrow instructions should provide specific information, such as: a. the conditions that must be met prior to the close of escrow

b. a list of items to be prorated

c. an explanation of the fees to be paid by the buyer and the seller

d. all of the above

2. The Residential Purchase Agreement and Deposit Receipt usually serve as the foundation for the escrow instructions. a. True

b. False

3. In Northern California, separate (unilateral) instructions for buyers and sellers are commonly used. a. True

b. False

Closing Escrow

As you read, think about:

• What the escrow officer must have in order to close escrow • Recording the deeds and disbursing the funds Once all of the steps discussed above have been completed, the escrow officer is ready to close escrow. The two most important steps of closing escrow are the recordation of the deeds and the disbursement of the funds.

Funding the Loan

Once the documents have been signed, the loan must be funded. This means that the escrow officer must secure a check from the lender to pay the seller for the balance owed on the property. Lenders will only release their money after they have received a funding package from the escrow officer. The funding package includes signed loan documents, the lender's escrow instructions executed by the borrower and escrow holder, a certified copy of the executed grant deed and trust deed, an original executed promissory note, the original escrow instructions and all amendments, the original fire insurance policy, and the original estimated closing statement. Upon receiving the funding package, the lender will authorize the escrow officer to record the necessary papers and will release the loan check. Make sure you know the timeframe required by the lender to receive documents before financing.

Recording the Deeds

The documents are recorded with the county recorder's office. Once a document is recorded, constructive notice has been given, and the public is assumed to have knowledge of its existence. Constructive notice is the notice given by recording, publishing in a newspaper, or other methods that legally notify the parties involved without actually notifying them personally or individually.

A deed is the instrument used to transfer title from one person to another, and a person holding a deed holds the title as represented by the writing in the deed. Recording deeds has become essential for buyers and lenders. In most cases, a recorded deed carries legal preference over an unrecorded deed. As soon as the title deed is recorded, a legal and binding transaction has occurred. Escrow is generally considered to be closed at the exact day, hour, and minute the deed is recorded. In other words, escrow closes when the property has legally changed hands.

Disbursing the Funds

Only after the documents have been recorded does the escrow officer release the monies held in the escrow account. At this point, everybody must be paid off: the seller, holders of old loans, termite companies, real estate agents, etc. The escrow officer disburses the funds according to the figures stated in the escrow instructions. Valid funds must be credited to the escrow holder's account before the escrow funds will be disbursed.

Cancelling Escrow

As you read, think about:

• The termination of escrow by mutual consent • What happens if the buyer or seller defaults When the buyer and seller signed the deposit receipt, they most likely agreed upon a time limit for closing the transaction, after which penalties could be charged to the party responsible for the delay, or the escrow could be cancelled altogether. The biggest concern when a transaction does not close and escrow must be cancelled is over how the funds already held in escrow will be released. Unless proper provisions have been made, their disbursement could be a problem. Escrow can be terminated by mutual consent of the buyer and seller for many different reasons, or it can be terminated by a failure on the part of the buyer or the seller to satisfy certain of the escrow conditions within a specified time.

Mutual Consent

Escrow instructions usually include a cancellation clause, enabling the buyer and seller to cancel the escrow by mutual written agreement. The escrow company may charge a cancellation fee to cover the cost of preparing the preliminary title report and any work that the company may have already done for the transaction. When one party decides not to go through with the purchase agreement, the agent for that party should notify the escrow officer and inform him or her as to the principal's reasons for requesting a cancellation. The escrow officer will then forward the request to cancel to the other parties involved, letting everyone know what is going on, so that any questions or disagreements can be resolved. The escrow officer should make all parties aware of the reasons for the cancellation and what will happen to the monies already held in escrow. The parties will need to know who gets the buyer's deposit, who pays for bills they may have already incurred, etc.

When Buyer and Seller Disagree

When the buyer and seller agree to end the transaction, canceling escrow is fairly simple. But when the buyer and seller disagree, or when either the buyer or the seller does not live up to the terms of the original purchase agreement, the cancelling of escrow becomes more complicated.

The purchase agreement and escrow instructions are legally binding contracts, enforceable in a court of law. Both the buyer and the seller can sue, depending on the circumstances involved. When writing up the purchase agreement, real estate agents should carefully explain the clause that provides for remedies to avert default by either party.

Summary

Until the escrow has closed, real estate agents cannot assume that they have finished with their work on a transaction. This chapter covered what too many real estate licensees ignore but all licensees should understand--the escrow process. We discussed the various duties of and escrow holder. It is important that a licensee is clear on what services the escrow officer or title company will provide. Many buyers (especially first-time buyers) are unfamiliar with the escrow process and will look to their real estate agent to explain what escrow is and how it works. We looked at the escrow process in general and took you through the basic steps of escrow in Northern and Southern California, since the process is not identical in the North and the South. You should now have a better understanding of how you, as a real estate licensee, fit into the escrow process. Real estate agents can help their buyers and sellers to open escrow and can assist the escrow officer by providing all the necessary documents and information needed for a smooth escrow. We touched on the purpose of a title search and described the most common title insurance policies used in California. Finally, we explained what happens to the documents and funds after escrow closes. By being better informed about the escrow process, you will be better prepared to see your clients to the completion of their transactions, from the beginning of the home buying or selling process through the close of escrow.

Appendix

Commonly Asked Questions About Escrow

1. Q: Can the recordation of documents occur prior to the disbursement of funds? A: Recordation of documents may occur prior to disbursement of funds if all

parties to the transaction consent in writing. 2. Q: In a purchase and sale transaction, who should select a title policy--a real estate broker or the principals? A: The type of policy to be issued in any particular transaction is a matter of contract between the principals (i.e., Buyer and Seller). The decision as to which type of policy to obtain can have serious legal consequences. While it is useful for a real estate licensee to have a basic knowledge of the different types of policies, specific coverage issues and the advisability of endorsements are matters for discussion and decision by the principals, their attorneys (if any), and the title company. 3. Q: Who is obligated to pay for the cost of a title policy? A: There is no law establishing which principal shall pay the cost of a title policy. This issue is negotiable between Buyer and Seller. In certain geographic regions of California, the custom and practice of the region dictates which party shall pay this cost. 4. Q: May a real estate broker have an ownership in an escrow or title company? A: Yes. There is no law which restricts the right of a real estate licensee to have an ownership interest in a title company. It is a violation of the Real Estate Law, however, to fail to disclose any significant interest a licensee has in an entity recommended by that licensee. 5. Q: May a real estate broker receive a referral fee from an escrow or title company for referring business? A: No. This is a violation of both the Real Estate Law and the federal Real Estate Settlement Procedures Act (RESPA), which applies to residential one-to-four unit dwellings with federally-related financing.

Appendix

Forms AD_sample(10.01).pdf AC-6_sample(1987).pdf TDS_sample(10.03).pdf AVID_sample(11.07).pdf NHD_sample(10.99).pdf WHSD_sample(11.07).pdf AS_sample(1.03).pdf AB_sample(2.91).pdf SFA_sample(10.02).pdf MS-11_sample(10.00).pdf FLD_sample(1.03).pdf HID-11_sample(8.99).pdf HOA_sample(10.02).pdf NCDS_sample(1.01).pdf RPA-CA_sample(1.06).pdf

C.A.R. Legal Memoranda

• California Withholding on the Sale of Real Property • California Civil Code Section 1101.2 (Exemptions from the Transfer Disclosure Statement) • Condominium or Other Common Interest Development Disclosures • Disclosure of Death and AIDS and the Prohibition Against Discrimination on the Basis of AIDS • Disclosure of the Existence of a Domestic Violence Shelter • Federal Flood Insurance Disclosure • Federal Lead-Based Paint Hazards Disclosure • Federal Withholding: The Foreign Investment in Real Property Tax Act (FIRPTA) • FHA Inspection Disclosure Form • Megan’s Law: Notifying the Public About Registered Sex Offenders • Mello-Roos District Disclosure Requirements • Natural Hazard Disclosure Statement • New Home Disclosure Chart • Real Estate Licensee’s Duty to Inspect Residential Property • Sales Disclosure Chart for REALTORS® • Smoke Detector Requirements • Summary Disclosure Chart for REALTORS® • Transfer Disclosure Statement Law • Water Heater Bracing and Disclosure Requirements

Note: Current legal memoranda are available only to C.A.R. members in the Legal section of C.A.R. Online. To access the memoranda, members should click on "Legal Q&As" and then "Legal Articles" in the Legal section.

Glossary

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You may also access this command from your Internet toolbar, by selecting Edit, then Find. Active Listing: Properties which are currently being offered for sale. Active listings are the competition for other similar properties for sale and indicate the upper limits of value for similar properties.

Ad Valorem: Based on value, as with ad valorem taxes on real property.

Adjustable Rate Loan (ARM): A loan with an interest rate that changes periodically, in relation to an index, and with payments that go up or down accordingly.

Adjusted Basis: The original basis of real estate (usually its purchase price), minus accumulated cost recovery and casualty losses, and plus the improvements.

Adjusted Selling Price: The gross sales price of a real property, less the selling and fixing-up expenses.

Agency Disclosure Statement: A written statement which contains a specific discussion of the types of agency in which one can be involved. The form and wording of this document is dictated by law and may not be modified.

Agency Confirmation Statement: A written statement which confirms that the listing broker represents the seller exclusively or both the seller and the buyer; and that the selling broker represents the seller exclusively, the buyer exclusively, or both the buyer and the seller. The wording of this document is also dictated by law. Both brokers, as well as the buyers and sellers, may sign the statement on a separate form or on the purchase agreement, as long as the required legislative language is used.

ALTA Owner's Policy: The ALTA Owner's policy affords more extensive coverage than does the CLTA Homeowner's endorsement. The ALTA policy may require a survey.

ALTA Lender's Policy: The American Land Title Association provides insurance "above and beyond" that provided by the CLTA Standard Coverage policy. The ALTA Lender's policy provides most of the additional coverage that lenders throughout the nation require, and its language is stronger than that of the CLTA policy. A lender that requests ALTA coverage will get a separate policy insuring its trust deed only.

ALTA Residential Policy: Only available on one-to-four residential properties, it provides more exclusive coverage than the CLTA Standard policy or ALTA Owner's policy.

Amendments to Escrow: A change to escrow, without changing the principal idea or essence. An escrow might be amended to correct an error, to alter an agreement, or to add to part of an agreement.

Appraisal: An opinion of the market value of real property as of a specified date; an estimate of value. Assessment: A charge of money for a specific purpose. For example, a condominium owner may receive an assessment for a proportionate share of some project expense.

Assumption: An agreement to take over another party's loan.

Balloon Loan: A loan which has payments that are usually amortized over a 30-year period, even though the remaining balance is actually due in full after a much shorter term (usually five to seven years). This results in a "balloon payment" at the end of that term.

Basis: Usually the original purchase price of real property, unless the real property was acquired by gift, inheritance, or in some way other than by purchase.

Beneficiary's Statement: The statement of a lender about the remaining unpaid principal due on a note and other information concerning the loan.

Bilateral Instructions: The type of escrow instructions used in Southern California. The buyer and seller sign the same set of instructions.

Bill of Sale: A written document used to transfer title to personal property.

Buy-down: A procedure by which a subdivider pays cash to a lender in return for a loan commitment to a home purchaser at below-market interest rates.

Cal-Vet Purchase Program: Administered by the California Department of Veterans Affairs, this is basically the state version of the VA Home Loan Guaranty Program. Funds are derived from the sale of California general obligation and revenue bonds to help low- and moderate-income home buyers obtain financing.

California Housing Finance Agency: CalHFA makes and insures below-market interest rate loans for low- and moderate-income first-time home buyers in California. As with FHA and VA loans, CalHFA home ownership loans are made directly through private lending institutions and are insured by either the FHA or the California Housing Insurance Fund.

CLTA Standard Policy: The California Land Title Association provides standardized forms for title insurance policies and endorsements. A uniform version of the CLTA Standard Coverage title insurance policy is available throughout California and insures the ownership of the estate or interest in the land described.

CLTA/ALTA Homeowner's Policy: This policy is only available on one-to-four residential properties. It provides greater coverage than the CLTA Standard policy, or ALTA Owner's or Residential policy and is required by the pre-printed language of the RPA-CA.

Community Facilities District: The Mello-Roos Community Facilities Act provides local governments with a more versatile tool to aid in the construction and maintenance of local public facilities. The Act allows local governments to create community facilities districts and levy special taxes. The taxes can then be used to repay bonds floated to finance public facilities. (See Mello-Roos District.) Comparable Sales: Properties which have recently sold. When doing a CMA, comparable sales represent the price buyers are willing to pay for similar properties.

Competitive Market Analysis (CMA): Pricing information about recent sales of homes in a certain neighborhood used to set an asking price for real property.

Constructive Notice: Notice given by public recordation. For example, recording a document that affects a specific parcel of real property gives constructive notice to the public of that document's contents.

Contract for Deed: With this kind of agreement, the seller promises to convey title when the purchaser fulfills the obligation called for in the contract. The contract usually requires the buyer to make predetermined installments to the seller until the amount of the purchase price is paid. Once the seller has been paid in full by the buyer, he must convey the title, without liens, to the buyer.

Conventional Loan: A loan, not insured by a government agency, which falls under the maximum loan limit set by Fannie Mae and Freddie Mac and conforms to Fannie Mae and Freddie Mac's underwriting guidelines.

Cost Approach: In appraisal, one way to determine the estimate of the market value of improved property. The cost of reproducing the improvements is determined by referring to prices existing at the valuation date. This cost is then reduced by accrued depreciation to take into consideration the age of the property.

Debt Ratio: Used to judge the qualification of a borrower for a home loan. Under current FNMA guidelines, a home buyer should not spend more than 29% of his monthly gross income on loan payments, including principal, interest, property taxes, and insurance. A maximum of 36% of monthly gross income should be spent on all combined debts.

Deed of Trust: A deed used to guarantee repayment of a debt. For all practical intents and purposes, a deed of trust is synonymous with a loan.

Depreciation: Both a decrease in value of real estate and an income tax benefit, depending on its usage. In taxation, a depreciation deduction from ordinary income is allowed the owner of certain improved real property. In appraisal, depreciation means a loss in market value.

Documentary Transfer Tax: A tax that a city or county may charge at the rate of $1.10 per $1,000 (or $0.55 per $500) on the value of real property exclusive of liens and encumbrances remaining at the time of sale.

Dual Agency: A situation in which one agent simultaneously represents two principals, a buyer and a seller.

Earthquake Fault Zone: An area designated by the State which may contain one or more potentially active earthquake faults that may be hazardous to structures because of "surface faulting" or "fault creep." The law which deals with these zones is the Alquist-Priolo Earthquake Fault Zones Act. Easton v. Strassburger: The famous court case, which formed the basis for a standard of conduct in California that licensees are obligated to follow. The case resulted in Civil Code §§2079 - 2079.10, which set forth the agent's duty to inspect.

Escrow: A process whereby a disinterested third party accepts written instructions from parties to a transaction and delivers held funds and documents in strict compliance with these instructions on close of escrow. Escrow closes when the appropriate documents are recorded and delivered, and the funds are disbursed.

Escrow Agent: The person having a fiduciary responsibility to the buyer, seller, and lender to see that the terms of the purchase/sale/loan are carried out according to the terms of the purchase agreement and escrow instructions.

Escrow Instructions: The written instructions addressed to an escrow by the parties to a real estate transaction. A typical escrow includes instructions from the seller, the buyer, and the lender.

Expired Listing: A property that is listed with a broker, but did not sell. Expired listings represent the price buyers are not willing to pay for similar properties.

FHA Loan Insurance Program: A loan insured by the Federal Housing Authority (FHA). The insurance guarantee encourages lenders to make home loans that otherwise would be too risky, and provides marketability in the secondary loan market.

FIRPTA: (Foreign Investment in Real Property Tax Act) imposes upon a buyer of real property an obligation to withhold 10% of the sales price of a U.S. real property interest, if the seller is a foreign person and to send that sum to the IRS, unless an exemption applies.

Fixed Rate Loan: A loan based on a promissory note that contains a fixed rate of interest. Because the interest rate is fixed, the monthly payments remain the same over the life of the loan.

Fixing-up Expenses: Expenditures paid for work performed on a residence to help sell it (e.g., repairs, painting, wallpapering, decorating), which are not deductible as selling expenses and normally not allowed to be added to adjusted basis as improvements.

Flood Hazard Area: An area designated by the federal government which is subject to flooding. If a seller's property is located in such an area, the seller should disclose this fact to the purchaser. The Federal Emergency Management Agency (FEMA) can provide a Flood Hazard Boundary Map identifying the flood hazard areas.

Funding Package: Lenders will only release their money after they have received a funding package from the escrow officer. The funding package includes signed loan documents, the lender's escrow instructions executed by the borrower and escrow holder, a certified copy of the executed grant deed and trust deed, an original executed promissory note, the original escrow instructions and all amendments, the original fire insurance policy, and the original estimated closing statement. Graduated Payment Loan (GPM): A loan with payments tailored to meet the qualifications of first-time home buyers. The interest rate is usually fixed over the life of the loan, but in the early years the monthly payments are lower than is required to service the loan. The monthly payments gradually rise above the level at which a standard fixed-rate loan would have been written, but by that time the homeowner is expected to be able to meet the increased payment with increased salary or income.

Grant Deed: A standard variety of deed used to transfer ownership in real property sales.

Gross Selling Price: For tax purposes, the amount realized on a sale. The gross selling price includes the amount of cash received plus the fair market value of any other property received.

Growing Equity Loan: A loan with a fixed interest rate, but with non-fixed payments, which is amortized over a set period (usually 30 years), but with payments that increase in size yearly by a predetermined amount. Initial monthly payments are the same as those of a fixed rate loan, but payments increase by predetermined amounts, and the increase is applied directly to the outstanding principal.

Improvement Bond Act of 1915: This act allows cities to make assessments and issue bonds for the improvement of streets and public ways. Civil Code §1102.6b requires the disclosure of Improvement Bond Act of 1915 assessments by the seller to the buyer.

Income Approach: In appraisal, an approach to estimate the market value of income property. The net income of a property is estimated and capitalized into an estimate of market value by applying an estimated capitalization rate.

Index: The interest rate on an adjustable rate loan is computed by using the "index" and "margin" together. The most common indexes used are U.S. Treasury Bills, U.S. Treasury Securities, Federal Home Loan Bank 11th District Cost of Funds, and London Interbank Offered Rate.

Installment Sale: A sale of real estate where the purchase price is paid in installments over a period of years.

Installment Method: The method of paying income taxes on the gain from an installment sale. Income taxes are payable by the seller in the years when principal payments are received, not in the year of the sale.

Interest Rate Cap: Most ARM's have interest rate caps, which control by how much the interest rate can rise or fall during each adjustment period as well as over the life of the loan.

Lease with Option to Buy: A lease that gives the tenant the right to purchase the property at a stated price and terms. A portion of the rent may count as part of the down payment, or price, in the event the option is exercised. Lease-Purchase Agreement: Under this agreement, the buyer agrees to rent the property from the seller until a predetermined time, at which point the buyer will purchase the property.

Loan-to-Value Ratio: The ratio of a loan to the market value of the real estate securing the loan.

Mandatory Disclosure: An item of information which is required by law to be conveyed from one entity involved in a real estate transaction to another entity in that same transaction.

Margin: The margin (a constant rate of usually 2% - 3%) is added to the index to determine the current interest rate for each adjustment period of an adjustable rate loan.

Market Value: In appraisal, an estimate of the worth of real estate at a particular time.

Mello-Roos District: A special assessment district to provide community facilities. Civil Code §1102.6b requires the disclosure of Mello-Roos districts by the seller to the buyer. (See Community Facilities District.)

Loan Insurance Premium (MIP): The annual charge made by the FHA as a premium for the insurance it provides against default on the loan.

Loan Disclosure Statement: If a real estate licensee is arranging financing for compensation or is making a loan with his own money, secured by a lien on real property, he must provide the borrower with a loan disclosure statement. The disclosure statement details the total costs of a loan to the borrower.

Loan Credit Certificate (MCC) Program: A program that allows low-income home buyers to claim a credit on their federal tax returns. Borrowers may be eligible for down payment and closing cost assistance through the MCC program.

Loan Revenue Bond Program: Under this program, state and local housing finance agencies issue loan revenue bonds and use the proceeds to provide low-interest loans to low-income buyers. Borrowers obtain loans at below-market interest rates, and may be eligible for down payment and closing cost assistance.

Most Beneficial Listing Price: The price that will produce a sale at the highest sales price and that will net the seller the most money possible, with the least amount of inconvenience, and within a reasonable time. This price is based on the CMA.

Natural Hazards Disclosure Statute: A disclosure required by Civil Code Sections 1103 - 1103.4 in residential properties with one-to-four units covering two flood, two fire and two earthquake/seismic hazards zones.

Negative Amortization: A gradual increase in loan debt. Negative amortization describes any situation where interest accrues on a loan at a faster rate than it is paid. The unpaid interest is added to the unpaid balance of the loan so that the debt increases accordingly.

Non-Conventional Loan: Home financing which is provided either directly or indirectly by a government agency. The agency can be an instrument of the federal (e.g., FHA), state (e.g., Cal-Vet), or local government (e.g., local MRB program).

Notice of Special Tax: If a property is located in a Mello-Roos District, the seller must disclose the necessary information by providing a Notice of Special Tax to the buyer. The seller must make a good faith effort to obtain the disclosure notice concerning the special tax from the local tax-levying agency and deliver the notice to the prospective buyer.

Ordnance Location: An area once used for military training purposes which may contain potentially explosive munitions.

Payment Caps: Instead of an interest rate cap, some ARM's have a payment cap, which limits how much the principal and interest payment can increase or decrease at each adjustment period.

Prelim: A document prepared by a title company which contains a summary of all pertinent documents that are recorded in the official records, as well as the current tax status of a particular parcel of real estate.

Principal Residence: In general, the land and building where the taxpayer principally domiciles. The principal residence will usually be the home in the area where the taxpayer works, votes, pays taxes, and spends the most time. A taxpayer cannot have more than one principal residence at any one time.

Principle of Anticipation: Value depends on anticipated future benefits.

Principle of Change: Trends in economic, physical, governmental, and social forces brought about by change in those forces may affect property values.

Principle of Competition: An individual listed property is in competition with other properties in its neighborhood and nearby communities.

Principle of Conformity: Value is maximized when a reasonable degree of sociological, architectural, and economic similarity exists.

Principle of Contribution: Value of a component part of a property depends upon its contribution to the value of the whole.

Principle of Highest and Best Use: The reasonable and probable use that supports the highest present value.

Principle of Progression: The value of a less expensive property tends to increase by association when placed among more valuable properties in the same area.

Principle of Regression: The value of a more expensive property tends to reduce by association when placed among less valuable properties in the same area. Principle of Substitution: A buyer will pay no more than the cost of a reasonable substitute of equal utility.

Principle of Supply and Demand: The greater the supply of an item, the lower will be its value; demand is created by scarcity, desirability, and purchasing power.

Private Loan Insurance (PMI): Enables home buyers to obtain conventional loans with relatively small down payments. PMI reduces the down payment required to as little as 5% and is obtained by lenders to protect themselves against the costs of foreclosure.

Promissory Note: The written evidence of a debt. A promissory note may be negotiable and is always assignable.

Regulation Z: A part of the federal Consumer Credit Protection Act that requires full disclosure of credit terms to consumers, including calculation of the annual percentage rate.

RESPA: A federal law requiring that parties to residential real estate transactions be provided with an accounting of all settlement charges and credits. The purpose is to avoid misunderstandings by home buyers about closing costs.

Right of Rescission Notice: Allows the buyer a last opportunity to cancel the loan within three working days of its receipt.

Sales Comparison Approach: The most commonly used of the three approaches to value. The licensee finds comparables (properties similar to the one for which he is trying to estimate value) and compares the selling prices of these to the subject property.

Seismic Hazard Zone: An area subject to strong ground shaking, liquefaction, landslide, or other specific types of ground failure. The law which deals with these zones is the Seismic Hazards Mapping Act.

Seller Carry-back Loan: A loan made by a seller to a buyer. This type of financing requires the seller to have enough equity in the property, or sufficient other assets, to make a loan to the buyer.

Seller Financing Disclosure Statement: Civil Code §2956 requires that both the buyer and seller be provided with a statement disclosing information regarding seller financing when the transaction involves the purchase of a one-to-four unit dwelling.

Selling Expenses: Costs incurred in the sale of real property.

Shared Equity Arrangement: An agreement between a borrower (owner- occupant) and an investor, under which the investor provides funds to pay for a specified share of the borrower's expenses in exchange for a share of the property appreciation and tax benefits. State Fire Responsibility Area: An area where the financial responsibility of preventing and suppressing fires primarily rests with the State of California. If real property is designated in such an area, the seller must disclose this fact to the buyer.

Statement of Information: Provides pertinent data on individuals and guards against forgeries. Title insurance companies normally require this statement on all individual grantors, grantees, and borrowers.

Title Insurance: A form of protection against surprise encumbrances on or claims to real estate. A title company prepares a report that refers to all recorded documents that affect the ownership or possession of a specific parcel of real estate. Some unrecorded encumbrances, such as property taxes, are reported as well. Title insurance is a form of guarantee that the title company's report is accurate (that is, the insured property owner is protected from losses that may be caused by the failure of the title company to properly report all encumbrances of record that effect the property).

Title Search: An analysis of the official records to identify and catalog those documents that pertain to a particular parcel of real estate. A title search ordinarily is performed by an attorney or a title company.

Transfer Disclosure Statement: Pursuant to California Civil Code §§1102 - 1102.15, a real estate transfer disclosure statement must be provided by the transferor of residential real property improved with one-to-four dwelling units to the transferee. The statement identifies whether specified items are contained in the residence or on the property and whether such items are operational; significant defects in certain structural components of the residence; and other information regarding improvements and alterations, as well as certain concerns with neighbors and the neighborhood.

Trust Account: Any account held by a fiduciary for the benefit of another. A real estate broker is required by law to maintain a trust account in which earnest money deposits are maintained.

Unilateral Instructions: The type of escrow instructions used in Northern California, whereby the buyer signs one set of instructions and the seller signs another.

VA Guaranteed Loan Program: A Veteran's Administration loan available to qualified veterans. Such a loan may feature little or no down payment and a below- market interest rate.

Value: The present worth of future benefits to typical users or investors arising out of the ownership of property. Generally, refers to market value (the price for which a property will sell in the open market if the seller is not under any extreme pressure to sell, and the buyer is not under any extreme pressure to buy).