7.4 Settlement, Closing Statements, and Prorations

What happens at settlement

Settlement (closing) is when title transfers, the loan funds, and money changes hands. The Closing Disclosure lists every charge as a debit (money a party owes) or a credit (money in a party's favor). Each party's debits and credits are totaled; the difference is the cash to close (buyer) or net proceeds (seller).

Learn these anchors:

• Sale price: debit to buyer, credit to seller.
• Earnest money deposit: credit to buyer (already paid).
• New loan amount: credit to buyer (loan pays part of the price).
• Loan payoff of seller's existing mortgage: debit to seller.
• Brokerage commission: typically a debit to seller.
• Recording the deed: usually buyer; recording the release: seller.

Debits and credits — who pays

A single expense usually creates mirror entries: a proration that is a debit to one party is a credit to the other for the same amount. That symmetry is a fast way to check your math: the buyer's debit for the seller's unpaid taxes equals the seller's credit-to-buyer (a seller debit).

Reconciling the statement and a worked cash-to-close

Every closing statement must balance: the buyer's total debits minus credits equals the cash the buyer brings, and the seller's credits minus debits equals the net proceeds. Working a full buyer line builds the intuition the exam rewards.

Worked cash-to-close: A buyer purchases for $300,000 with a new $240,000 loan and a $5,000 earnest-money deposit already paid; buyer-side closing costs total $4,200, and the buyer owes the seller a $1,800 prepaid-tax reimbursement.

• Buyer debits: $300,000 price + $4,200 costs + $1,800 tax reimbursement = $306,000.
• Buyer credits: $240,000 loan + $5,000 deposit = $245,000.
• Cash to close = $306,000 - $245,000 = $61,000.

Trap: A proration is a mirror entry — one party's debit equals the other's credit for the identical amount. If your buyer debit and seller credit do not match to the penny, you have mis-assigned arrears vs. prepaid or used the wrong day count.

Proration basics

Prorations divide recurring shared expenses fairly as of the closing date so each party pays only for the period they own the property. Common prorated items: property taxes, HOA/condo dues, prepaid rent, and interest. The exam usually states a convention:

• Banker's/statutory year: 360 days, 30-day months (simpler math; most common on exams).
• Actual/calendar year: 365 days, actual days in each month (more precise).

Also watch who owns closing day: many problems say the seller owns the day of closing (pays through closing day), but always follow the convention the question gives. Decide whether the item is paid in arrears (after the fact, like many property taxes) or prepaid (in advance, like HOA dues or rent).

Worked proration — property taxes in arrears

Annual property tax = $3,600, paid in arrears. Closing is April 1; the seller owns Jan 1 through March 31 (3 months) and has not yet paid the year's taxes. Using the 360-day method:

• Monthly tax = $3,600 / 12 = $300/month.
• Seller's share = 3 months x $300 = $900.

Because taxes are unpaid and the buyer will pay the full bill later, the seller must reimburse the buyer for the seller's ownership period: $900 is a debit to the seller and a credit to the buyer. If instead the seller had prepaid the full $3,600 in January, the buyer would owe the seller for the 9 remaining months (9 x $300 = $2,700): a credit to the seller, debit to the buyer. Always identify prepaid vs. arrears before assigning the direction.

Worked proration — prepaid rent on an investment property

A tenant paid $1,500 rent for the full month of June on June 1. Closing is June 16, and the seller owned the property June 1-15 (15 days) while the buyer owns June 16-30 (15 days) under a 30-day month.

• Daily rent = $1,500 / 30 = $50/day.
• Buyer's share (15 days) = $750.

Since the seller already collected the entire month's rent, the seller owes the buyer for the days the buyer owns: $750 is a debit to the seller and a credit to the buyer. The same logic applies to security deposits, which transfer in full as a seller debit / buyer credit because the deposit belongs to the tenant and the buyer becomes the new landlord obligated to refund it.

Common settlement traps and the RESPA tie-in

A few patterns trip up test-takers. First, direction of arrears vs. prepaid: with arrears (taxes usually), the seller credits the buyer; with prepaid items (rent, HOA, insurance), the buyer credits the seller. Reversing the direction is the most common error. Second, the lesser-of rule does not apply to prorations — that rule is for LTV; prorations always use the contract's stated annual amount. Third, watch the day-count convention the question gives; a 365-day answer differs slightly from a 360-day answer, so use exactly what is stated.

Settlement also reconnects to RESPA: at closing the borrower receives the final Closing Disclosure, and the lender may collect a limited escrow (impound) reserve for taxes and insurance. A licensee who pressures a buyer to use a specific affiliated title or escrow company for a referral fee can violate RESPA at the closing stage, so the financing and settlement chapters connect directly.