7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- Closing statements record each item as a debit (charge owed) or credit (amount in favor); the sale price is a buyer debit and seller credit.
- The buyer's new loan and earnest money are buyer credits; commission and the seller's loan payoff are seller debits that reduce net proceeds.
- Prorations split shared costs by who used the period—use the 360-day (banker's) method unless the question specifies the 365-day actual method.
- Items paid in arrears (unpaid taxes) create a seller debit/buyer credit; items prepaid by the seller create a buyer debit/seller credit reimbursement.
- Seller's net = price minus payoff, commission, and prorated debits; buyer's cash to close = price plus costs minus earnest money, new loan, and credits.
What Happens at Closing
Settlement (closing) is the event where title transfers, funds change hands, and the transaction is finalized. The closing statement itemizes every dollar as a debit (charge owed by a party) or a credit (amount in a party's favor). Each party has a separate column, and each column's debits and credits must balance.
A single item often appears on both sides: the sale price is a debit to the buyer (the buyer owes it) and a credit to the seller (the seller receives it). Understanding which side an item lands on—and for whom—is the core skill the exam tests in closing-statement questions.
Debits and Credits Cheat Sheet
| Item | Buyer | Seller |
|---|---|---|
| Sale price | Debit | Credit |
| Earnest money already paid | Credit | — |
| New loan amount (buyer's mortgage) | Credit | — |
| Seller's existing loan payoff | — | Debit |
| Brokerage commission | — | Debit |
| Prepaid property taxes (seller paid ahead) | Debit | Credit |
| Unpaid property taxes (accrued, not yet paid) | Credit | Debit |
The buyer's new loan is a credit to the buyer because that money helps pay the price. The seller's loan payoff and commission are debits to the seller, reducing the seller's net proceeds.
Prorations: Splitting Shared Expenses
Proration divides ongoing costs (property taxes, HOA dues, prepaid rent, interest) fairly between buyer and seller as of the closing date. The party who used the period pays for it.
Two conventions appear on exams:
- Statutory/banker's year — 360 days, 30 days per month. Simpler arithmetic.
- Actual (365-day) year — uses the real number of days.
Unless a question says otherwise, use the 360-day method if it gives clean numbers, or follow the method the question specifies. Always note who pays the day of closing (commonly the seller owns through the day before closing, but follow the question's stated rule).
Worked Proration: Property Taxes (Seller Paid in Arrears)
Annual taxes are $3,600, unpaid (paid in arrears). Closing is April 30. The seller owes for January through April (the period the seller owned). Using the 360-day method:
- Daily rate = $3,600 / 360 = $10/day
- Seller's period = 4 full months (Jan-Apr) = 120 days
- Seller's share = 120 × $10 = $1,200
Because taxes are unpaid, the seller owes this $1,200 to the buyer (who will pay the full bill later). Result: $1,200 debit to the seller, $1,200 credit to the buyer.
Annual property taxes of $4,800 are paid in arrears (unpaid). Closing is June 30 and the seller is responsible through the closing date. Using the 360-day method, what is the proration?
Worked Proration: Prepaid Item (Seller Paid Ahead)
Now flip it. The seller prepaid a $1,440 annual insurance/HOA-type expense for the full year on January 1, and closing is at the end of September (270 days used by the seller, 90 days remaining). Using the 360-day method:
- Daily rate = $1,440 / 360 = $4/day
- Remaining (buyer benefits) = 90 days × $4 = $360
The buyer will enjoy the last 90 days the seller already paid for, so the buyer reimburses the seller: $360 debit to the buyer, $360 credit to the seller. Rule of thumb: prepaid by seller → buyer reimburses (buyer debit/seller credit); paid in arrears → seller owes (seller debit/buyer credit).
Computing Seller's Net and Buyer's Cash to Close
- Seller's net proceeds = sale price − (loan payoff + commission + seller's prorated debits + other seller costs) + seller's prorated credits.
- Buyer's cash to close = price + buyer's closing costs + buyer's prorated debits − (earnest money + new loan + buyer's prorated credits).
Worked example: Price $300,000; seller loan payoff $180,000; 6% commission = $18,000; seller tax debit $1,200. Seller's net = $300,000 − $180,000 − $18,000 − $1,200 = $100,800. Many exam questions are exactly this subtraction chain—identify each debit, subtract from the price, and you have the seller's bottom line.
Who Pays What — Customary Allocation
Many closing costs are negotiable, but exams expect familiarity with customary allocations:
| Cost | Usually paid by |
|---|---|
| Loan origination fee, points, appraisal | Buyer |
| Lender's title policy, recording the mortgage | Buyer |
| Brokerage commission | Seller |
| Owner's title policy (in many areas) | Seller |
| Transfer/conveyance tax | Often seller (varies) |
Remember these are defaults, not law — the purchase contract controls. Items the buyer prepays at closing (such as the first year of hazard insurance and an initial escrow deposit) raise the buyer's cash to close but are not prorations; they are separate charges.
Interest Proration on the New Loan
Mortgage interest is paid in arrears, so at closing the buyer typically owes prepaid (per diem) interest from the closing date to the end of the month, since the first regular payment will not cover that gap.
Worked example: New loan $240,000 at 5% annual interest, closing on the 20th with 11 days remaining in a 30-day month. Daily interest = ($240,000 × 0.05) / 360 = $12,000 / 360 = $33.33/day. Prepaid interest = 11 × $33.33 = $366.63, a debit to the buyer. This is one of the most common per-diem calculations on the closing portion of the licensing exam.
On a closing statement, which item is a CREDIT to the buyer?