7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- On a closing statement, a debit is a charge owed by a party and a credit is money in that party's favor; the sales price is a debit to the buyer and a credit to the seller.
- Prorations divide ongoing expenses (taxes, HOA dues, prepaid rent) fairly between buyer and seller as of the closing date.
- Accrued items (owed but unpaid, like arrears taxes) are credited to the buyer and debited to the seller; prepaid items reverse this.
- Earnest money already paid is a credit to the buyer; the new loan amount is a credit to the buyer and is not a seller item.
- The statutory (banker's) year method uses 360 days and 30-day months unless the problem specifies a 365-day actual-days calculation.
Debits and credits
A settlement (closing) statement reconciles what each party owes and receives. The two columns:
- Debit = a charge against a party (money that party must pay).
- Credit = money in a party's favor (something paid or owed to them).
The buyer's debits minus credits show cash needed to close; the seller's credits minus debits show net proceeds.
| Item | Buyer | Seller |
|---|---|---|
| Sales price | Debit | Credit |
| Earnest money (already paid) | Credit | — |
| New loan amount | Credit | — |
| Seller's existing loan payoff | — | Debit |
| Unpaid (accrued) property taxes | Credit | Debit |
| Prepaid taxes/HOA by seller | Debit | Credit |
The sales price is the seller's big credit and the buyer's big debit. Earnest money the buyer already deposited is a buyer credit (it reduces remaining cash to close). The new loan is a buyer credit because the lender supplies that money on the buyer's behalf — it is never a seller item.
Trap: a single proration appears on both statements but in opposite columns. Unpaid taxes the seller owes become a debit to the seller and a matching credit to the buyer, who will pay the full bill later.
Prorations
Prorating splits a recurring expense fairly as of the closing date. Two categories:
- Accrued (arrears) items — owed but unpaid (e.g., property taxes paid in arrears). The seller owes their share; it is debited to the seller, credited to the buyer.
- Prepaid items — paid in advance by the seller beyond closing (e.g., prepaid HOA, prepaid insurance the buyer assumes). The buyer reimburses; debited to the buyer, credited to the seller.
The 360-day (banker's/statutory) method
Unless told to use actual days, assume a 360-day year and 30-day months.
Worked example — taxes paid in arrears. Annual taxes are $3,600; closing is April 30; seller has paid nothing yet. The seller owes for time owned (Jan 1 through April 30 = 4 months).
- Daily/monthly rate: $3,600 ÷ 12 = $300 per month.
- Seller's share = 4 months × $300 = $1,200.
- Entry: debit seller $1,200, credit buyer $1,200 (buyer will pay the full $3,600 bill later but is reimbursed for the seller's months).
Worked example — prepaid HOA. Seller prepaid $600 for a 6-month period ($100/month) and closes exactly 2 months into it, leaving 4 months the buyer benefits from.
- Buyer reimburses 4 × $100 = $400: debit buyer $400, credit seller $400.
Rent received in advance (income property). If the seller collected $1,500 rent for the month and closing is on day 10 of a 30-day month, the buyer is entitled to the remaining 20 days:
- $1,500 ÷ 30 = $50/day × 20 days = $1,000 credited to buyer, debited to seller (seller holds rent for days they will not own the property).
Day-count conventions
- 360-day method: 12 months × 30 days; simpler arithmetic; default on most exams.
- 365-day (actual) method: divide annual amount by 365 and multiply by exact days; used when a problem says "actual days" or "calendar year."
Always confirm who pays for the day of closing — many problems assign the closing day to the seller; read the instructions.
A worked net-to-seller and cash-to-close
Putting the columns together, suppose: sales price $300,000; seller's loan payoff $185,000; brokerage commission 6% ($18,000); seller's other closing costs $2,400; unpaid taxes prorated to seller $1,200.
- Seller credits: sales price $300,000.
- Seller debits: payoff $185,000 + commission $18,000 + costs $2,400 + tax proration $1,200 = $206,600.
- Seller net proceeds: $300,000 − $206,600 = $93,400.
Now the buyer side: sales price $300,000 (debit); new loan $240,000 (credit); earnest money $5,000 (credit); buyer closing costs $4,000 (debit); tax proration credit $1,200.
- Buyer debits: $300,000 + $4,000 = $304,000.
- Buyer credits: $240,000 + $5,000 + $1,200 = $246,200.
- Cash the buyer must bring to close: $304,000 − $246,200 = $57,800.
The single tax proration appears on both statements: a debit to the seller and a credit to the buyer, because the seller owes for the months they owned the property and the buyer will pay the full bill when it comes due. Mastering the debit/credit placement, then layering prorations on top, is the whole skill the settlement portion of the exam tests.
Annual property taxes of $2,400 are paid in arrears. Closing is June 30 and the seller has paid nothing. Using the 360-day method, what is the proration entry?
On a buyer's closing statement, how is the new loan amount the buyer is obtaining recorded?
Title, RESPA disclosures, and Kentucky closing custom
Settlement is also where title transfers and federal disclosure rules converge. Before closing, the title search and title commitment confirm marketable title; at closing, the deed delivers and the closing agent records it, after which title insurance issues. RESPA's Closing Disclosure must reach the borrower at least three business days before consummation, giving time to compare final figures against the Loan Estimate — a deadline the settlement portion of the exam loves to test.
Who conducts the closing, and where
Closing practice is regional, and Kentucky has a settled custom: residential closings are commonly conducted by a closing attorney or a title/escrow company, and Kentucky property taxes are paid in arrears, so the seller is almost always debited for the portion of the unpaid year they owned. A Kentucky-flavored proration item therefore defaults to "seller owes back taxes through closing," not a prepaid refund.
| Closing element | Typical treatment |
|---|---|
| Who closes | Attorney or title company (KY custom) |
| Property taxes | Paid in arrears; seller debited |
| CD delivery | 3 business days before closing |
| Recording | Closing agent records the deed |
The exam reward is matching the document to the duty: the Closing Disclosure governs timing, the settlement statement allocates debits and credits, and the title policy protects against defects — three distinct instruments that all converge at the closing table.