Agents can define 'settlement costs' in sales contract to protect clients

A closing at Federal Title last week resulted in a dispute between the buyer and seller over the definition of "settlement costs" that could have been avoided had the GCAAR Regional Sales Contract better defined the term.

I'll get to the language in just a moment real estate agents, but first let me tell you what the dispute was all about so your clients can avoid a similar situation at the settlement table.

In this case the seller had agreed to give the buyer a credit of $20,000 toward the buyer's settlement costs as per the GCAAR Addendum of Clauses paragraph #1. The contract provision read as follows:

"In addition to any other amount(s) the Seller has agreed to pay under other provisions of this Contract, the Seller shall credit the Buyer at the time of Settlement with the sum of $20,000 toward Purchaser’s settlement costs. It is the Buyer’s responsibility to confirm with his Lender, if applicable, that the entire credit provided for herein may be utilized. If Lender prohibits the Seller from payment of any portion of this credit, then said credit shall be reduced to the amount allowed by Lender."

Specifically, the 6-month Montgomery County, MD tax bill of $3,700 was itemized as a charge to the buyer on the HUD-1 Settlement Statement. This tax bill was required to be collected and paid at the time of closing as a requirement for recording the deed with the Montgomery County, MD clerk’s office. Further, this tax bill covered future taxes to the benefit of the buyer, covering the tax period of January 1-June 30, 2013.

In most cases, a lender will not allow any prepaid items (i.e., taxes, escrows, etc.) to be counted as settlement costs against the seller credit. However, in this case the lender allowed all settlement costs, including prepaid items, to be counted against the seller credit.

The seller argued that the $3,700 tax bill was not a "settlement cost" and thus, the credit should be reduced to $16,300. The buyer, on the other hand, argued that all items appearing on the HUD-1 Settlement Statement should be defined as "settlement costs" and that definition should include the prepaid taxes in this case since the payment of the taxes was a condition of closing – the taxes had to be collected by Federal Title and paid to Montgomery County, MD clerk’s office in order to record the deed.

Since "settlement costs" are not defined in the GCAAR Regional Sales Contract, the parties languished for a good length of time over the meaning and whether prepaid taxes should count against the seller credit.

How can real estate agents protect their homebuyers?

Agents would be well-advised in representing their client’s best interest to add their own definition of the term "settlement costs" to the GCAAR Regional Sales Contract. For example, if you are acting as a buyer agent where a seller credit exists, I would recommend adding an addendum or additional provision to the contract that reads:

"The parties understand and agree that "settlement costs," as the term is used throughout this entire contract of sale, shall mean all charges itemized and charged to the buyer on the HUD-1 Settlement Statement, including, but not limited to, prepaid and pro-rated taxes, escrow reserves, and prepaid interest, and as allowed by the buyer’s lender."

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