7.4 Settlement, Closing Statements, and Prorations

Debits and Credits

The closing statement is a balance sheet for the transaction. Every entry is either a debit (a charge against a party, money that party must produce or that reduces what they receive) or a credit (money owed to or already provided by a party).

The foundational entry: the sale price is a debit to the buyer (the buyer owes it) and a credit to the seller (the seller is owed it). From there, costs and adjustments are added to each side until both columns balance. The buyer's bottom line is the cash to close; the seller's bottom line is the net proceeds.

Common Buyer and Seller Items

Table: Typical Debits and Credits

Note that earnest money is a credit to the buyer because it was already deposited; it reduces the cash the buyer still owes. The new loan amount is also a buyer credit because the lender supplies those funds. The seller's loan payoff and commission are debits that reduce net proceeds.

Prorations: The Core Idea

Many expenses are shared across the closing date because they cover a period of time, not a single moment. Proration divides the expense by who owned the property on each day.

The direction depends on whether the item was prepaid or paid in arrears:

• Seller prepaid (e.g., paid the full year's insurance or HOA dues): the buyer reimburses the seller for the unused days. Result: debit buyer, credit seller.
• Seller owes but hasn't paid / paid in arrears (e.g., property taxes billed after the period): the seller credits the buyer for the seller's share, since the buyer will later pay the whole bill. Result: credit buyer, debit seller.

Always read whether the closing-date day itself belongs to the seller or the buyer; the exam will tell you.

Day-Count Methods

Two methods exist, and the question will specify which to use.

• Statutory / banker's year: 360 days, with each month treated as 30 days. Simpler arithmetic.
• Actual / calendar year: 365 days using the real number of days in each month.

Worked example (annual tax proration, 360-day method). Annual property tax is 3,600, paid in arrears. Closing is on the last day of September; the seller is responsible through closing.

Daily tax = 3,600 / 360 = 10 per day. Seller's ownership = January through September = 9 months at 30 days = 270 days. Seller's share = 270 x 10 = 2,700.

Because taxes are paid in arrears, the buyer will pay the full year later, so the seller's 2,700 share is a credit to the buyer and a debit to the seller.

Rent and Interest Prorations

Prorations are not limited to taxes. On an income property, prepaid rent collected by the seller for the closing month must be split: the seller keeps the days before closing and credits the buyer for the remaining days, since the buyer owns the property then. The result is typically a credit to the buyer, debit to the seller.

Mortgage interest on most loans is paid in arrears, so when a seller pays off an existing loan, accrued interest from the last payment to the payoff date is the seller's responsibility. Security deposits held by the seller transfer fully to the buyer as a credit to the buyer, because the buyer becomes responsible for refunding tenants.

Reading the Statement Like the Exam

A reliable approach for any proration question:

1. Identify the expense and its annual or monthly amount.
2. Compute the daily rate using the specified 360 or 365 method.
3. Count the days belonging to each party, watching whether the closing date is the seller's or the buyer's.
4. Decide direction: prepaid by seller means debit buyer / credit seller; paid in arrears means credit buyer / debit seller.
5. Place the figure on both sides so the statement balances.

The single most common error is reversing the direction. Anchor on this: if the seller already paid, the buyer pays them back; if the seller has not yet paid, the seller gives the buyer the money.

Worked Proration: Property Taxes

Prorations split shared costs as of the closing date. Two methods appear: the statutory/banker's year (360 days, 30-day months) and the actual/365-day year.

Worked example (365-day, taxes paid in arrears): Annual taxes are $3,650, so the daily rate is $3,650 / 365 = $10/day. Closing is on day 120 of the year, and the seller owned the property for those 120 days. The seller owes the buyer 120 x $10 = $1,200 as a credit to the buyer (a debit to the seller), because the buyer will later pay the full bill.

Who Gets Charged at Closing

Exam trap: Taxes paid in arrears mean the seller owes the buyer for the days the seller owned, the seller is debited and the buyer credited.