7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- On a closing statement, a debit is a charge to a party and a credit is money in that party's favor; the purchase price is a debit to the buyer and a credit to the seller.
- Prorations divide shared expenses between buyer and seller as of the closing date so each pays only for the time they own the property.
- Items paid in arrears (like property taxes) typically result in a seller debit and buyer credit; items paid in advance result in a seller credit and buyer debit.
- The earnest money deposit appears as a credit to the buyer because it was already paid toward the purchase.
Debits and credits at closing
A closing (settlement) statement reconciles what each party owes and receives.
- Debit = a charge against a party (money they must bring or that reduces their proceeds).
- Credit = an amount in favor of a party (money they receive or that reduces what they owe).
The purchase price is the anchor entry: it is a debit to the buyer (they owe it) and a credit to the seller (they receive it).
Common entries:
| Item | Buyer | Seller |
|---|---|---|
| Purchase price | Debit | Credit |
| Earnest money deposit | Credit | (none) |
| New loan amount | Credit | (none) |
| Existing loan payoff | (none) | Debit |
| Broker commission | (none) | Debit |
Why earnest money is a buyer credit
The buyer already deposited earnest money into escrow, so it counts toward the price they owe -> credit to buyer. The new loan the buyer obtains is also a buyer credit because that money is paid to the seller on the buyer's behalf.
For the seller, the unpaid balance of their existing mortgage must be paid off from proceeds -> seller debit. The commission owed to the brokerage is likewise a seller debit (in a typical seller-paid arrangement).
Trap: a single item is rarely a debit to both parties. Prorations are the exception: a prorated expense is usually a debit to one side and a credit to the other for the same dollar amount.
On a buyer's closing statement, how does the buyer's new mortgage loan appear?
Prorations: the concept
Proration splits a continuing expense so each party pays only for the period they own the property. The exam usually specifies a method:
- Statutory / banker's year — 360 days, 30 days per month (simpler math).
- Calendar year — 365 days, actual days per month (more precise).
- Through the day of closing — note whether the seller owns the closing day (affects whether you count that day).
Two timing patterns:
- Paid in arrears (e.g., property taxes billed at year-end): the seller used the service but has not paid -> seller debit, buyer credit.
- Paid in advance (e.g., prepaid HOA dues, prepaid insurance): the seller already paid past closing -> seller credit, buyer debit.
Worked proration: taxes in arrears
Annual property taxes are $3,600, unpaid (in arrears). Closing is April 30; seller owns Jan 1-Apr 30 (4 months). Use the 360-day method.
- Daily/monthly rate: $3,600 / 12 = $300 per month.
- Seller's share (Jan-Apr) = 4 x $300 = $1,200.
- Because taxes are unpaid and the buyer will pay the full bill later, the seller owes their share now: seller debit $1,200, buyer credit $1,200.
Worked proration: prepaid item
Seller prepaid a $1,200 annual HOA fee on Jan 1. Closing June 30 (seller owned 6 months). Seller used 6 months ($600) and prepaid 6 months past closing ($600) that the buyer benefits from. -> buyer debit $600, seller credit $600. The buyer reimburses the seller for the prepaid period.
Daily-rate prorations
When closing falls mid-month, compute a daily rate. Annual taxes of $2,920 on the 365-day method give 2,920 / 365 = $8 per day. If the seller owns through closing on March 15, count actual days owned (Jan 31 + Feb 28 + Mar 15 = 74 days): 74 x $8 = $592 seller share. With the 360-day method instead, the monthly rate is 2,920 / 12 = $243.33 and the daily rate is $243.33 / 30 = $8.11.
Watch the method and the closing-day rule. A question that says "seller responsible through the day of closing" includes that day; "buyer owns the day of closing" excludes it. A one-day difference rarely changes the answer choice, but the method (360 vs 365) often does, so read the prompt before reaching for a number. Always confirm whether the item is paid in arrears or in advance before deciding who is debited.
Settlement roles and the cash to close
At settlement, a neutral closing/escrow agent (or attorney, depending on the state) collects funds, prorates expenses, records documents, and disburses money. Funds are held in escrow — a neutral third-party account — until all conditions are met.
The buyer's cash to close is built from the closing statement: total buyer debits minus total buyer credits.
- Buyer debits: purchase price + closing costs + prepaid/escrow items + any prorations owed.
- Buyer credits: earnest money + new loan + seller concessions + prorations in the buyer's favor.
Trap: the seller's net proceeds equal seller credits (mainly the price) minus seller debits (loan payoff, commission, prorated taxes in arrears, transfer charges). A higher contract price does not guarantee higher net if payoff and costs are large. Title insurance, recording fees, and who pays them are often negotiated and shown as the appropriate party's debit.
California Settlement: Escrow, Transfer Tax, and Tax Prorations
California closings run through a neutral escrow holder rather than an attorney, and the state adds specific charges and a tax-calendar quirk the DRE tests.
The Documentary Transfer Tax
Counties levy a documentary transfer tax of $0.55 per $500 of value conveyed (equivalently $1.10 per $1,000), and many cities add their own transfer tax on top. It is computed on the price net of any assumed loan that remains. Worked example: a home sells for $700,000 with no assumed loan. County transfer tax = $700,000 / $500 = 1,400 increments x $0.55 = $770. If the buyer instead assumed a $200,000 existing loan, the tax is figured on the remaining $500,000 = $550. The transfer tax is typically a seller debit but is negotiable.
California's Property-Tax Calendar and Prorations
California property taxes run on a fiscal year of July 1 to June 30, billed in two installments: the first due November 1 (delinquent December 10) and the second due February 1 (delinquent April 10). Remember the mnemonic "No Darn Fooling Around" — Nov, Dec, Feb, April. At closing the escrow holder prorates the annual tax between buyer and seller based on the closing date and whether the installment has been paid.
| Installment | Due | Delinquent | Covers |
|---|---|---|---|
| First | Nov 1 | Dec 10 | Jul 1 - Dec 31 |
| Second | Feb 1 | Apr 10 | Jan 1 - Jun 30 |
A Worked California Proration
A sale closes September 30 with annual taxes of $6,000 unpaid. Using the 360-day method, the monthly rate is $6,000 / 12 = $500. The seller owned July 1 through September 30 of the fiscal year = 3 months = 3 x $500 = $1,500. Because the taxes are unpaid and the buyer will pay the full bill, the seller's share is a seller debit $1,500, buyer credit $1,500. If the seller had prepaid the first installment past the closing date, the entry would flip to a seller credit.
Trap: California's tax year starts July 1, not January 1. A proration question that assumes a calendar-year start for California property taxes is a common miss; count the seller's ownership from the July 1 fiscal-year start when the question specifies California.
Annual property taxes of $4,800 are paid in arrears. Closing is on March 31 and the seller owned the property for the first three months of the year. Using a 360-day (30-day month) proration, how does the tax proration appear?