7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- Debits to the buyer increase cash required; credits reduce it; the reverse logic affects seller proceeds.
- Purchase price is a debit to the buyer and a credit to the seller; earnest money and loan proceeds are buyer credits.
- Unpaid (accrued) expenses are a seller debit and buyer credit; prepaid expenses reverse the entries.
- Prorate using either a 360-day or 365-day year as the question specifies.
- One discount point equals 1% of the loan amount and lowers the interest rate.
The Closing Statement: Debits and Credits
At settlement, a closing statement (today the Closing Disclosure) allocates every cost between buyer and seller using debits (charges owed) and credits (amounts to the party's benefit). The core logic:
- A debit to the buyer increases the cash the buyer must bring.
- A credit to the buyer reduces the cash the buyer needs.
- A debit to the seller reduces the seller's net proceeds.
- A credit to the seller increases the seller's net proceeds.
The purchase price is a debit to the buyer and a credit to the seller. The buyer's earnest money is a credit to the buyer (already paid). New loan proceeds are a credit to the buyer. Many items are double entries — a debit to one party and a credit to the other.
Common Allocation of Costs
| Item | Buyer | Seller |
|---|---|---|
| Purchase price | Debit | Credit |
| Earnest money deposit | Credit | — |
| New mortgage loan | Credit | — |
| Seller's existing loan payoff | — | Debit |
| Unpaid property taxes (accrued) | Credit | Debit |
| Prepaid taxes (paid ahead) | Debit | Credit |
When the seller owes for something not yet paid (accrued taxes), the buyer who will pay it later receives a credit and the seller takes the debit. When the seller prepaid an expense covering time after closing, the buyer reimburses the seller — a debit to the buyer, credit to the seller.
Prorations — Method and Worked Example
Proration divides a recurring cost between buyer and seller as of the closing date. Exams use either a 360-day (banker's) year with 30-day months or a 365-day (actual) year — read the question for which.
Worked example (360-day): Annual property tax is $3,600; the seller has not paid it; closing is April 1. The seller owes for Jan, Feb, Mar = 3 months.
- Monthly tax = $3,600 / 12 = $300.
- Seller's share = 3 months x $300 = $900.
- Result: $900 debit to seller, $900 credit to buyer (buyer will pay the full bill later).
If taxes were prepaid for the full year, the proration would reverse: the seller would get a credit for the post-closing months and the buyer a matching debit.
Settlement Costs and the Agent's Role
Typical buyer costs: loan origination and discount points, appraisal, the lender's title policy, recording the deed and mortgage, and prepaid interest. Typical seller costs: real estate commission, owner's title policy (in many areas), transfer taxes, and the existing loan payoff.
One discount point equals 1% of the loan amount and buys down the interest rate. On a $200,000 loan, 2 points = $4,000. Real estate licensees do not prepare the final figures, but they must understand the statement to explain it to clients, verify their commission entry, and ensure the contract's negotiated cost allocations are reflected. Misreading a debit as a credit is a classic exam error — always tie the entry back to who ultimately benefits.
Reconciliation and the Balanced Statement
A correct closing statement balances: the buyer's total debits minus total credits equals the cash the buyer must bring, and the seller's total credits minus total debits equals the seller's net proceeds. If the two sides do not reconcile, an entry was placed on the wrong side or omitted.
A quick worked check: buyer owes $250,000 (price) + $4,000 (closing costs) = $254,000 in debits; buyer has $200,000 (loan) + $10,000 (earnest money) = $210,000 in credits. Cash to close = $254,000 - $210,000 = $44,000.
Remember the proration boundary convention your jurisdiction uses: many exams charge the seller through the day before closing and credit the buyer from the closing date forward. Always confirm whether the day of closing belongs to the buyer or seller before assigning shares, because a one-day shift changes the answer on tightly written proration questions.
Worked Example: A Full Proration at Closing
Most closing items are prorated as of the closing date so each party pays only for the period they own the property. Use the exam's common 360-day (banker's) year / 30-day month unless told otherwise, and decide who is responsible on the day of closing (typically the seller pays through the day before closing).
Annual property tax is $3,600, unpaid, and closing is April 16.
- Daily tax = $3,600 / 360 = $10/day.
- Seller owns Jan 1 through April 15 = 3 full months (90 days) + 15 days = 105 days.
- Seller's share = 105 x $10 = $1,050.
- Because the tax is unpaid (buyer will pay the full bill later), this is a debit to the seller and a credit to the buyer of $1,050.
If the tax had been prepaid, the direction reverses: the buyer reimburses the seller (credit seller / debit buyer) for the buyer's share of the remaining period.
Debits, Credits, and the Balancing Rule
On a settlement statement a debit is a charge (money a party owes) and a credit is money in a party's favor. The sale price is a debit to the buyer and a credit to the seller. Earnest money already paid is a credit to the buyer. The buyer's new loan is a credit to the buyer; the seller's loan payoff is a debit to the seller. Each side's debits and credits must net to the same cash-to-close / proceeds figure for the statement to balance — if it does not balance, an item was placed on the wrong side, which is the most common arithmetic error the exam plants.
Annual property taxes of $4,800 are unpaid at closing on July 1, using a 360-day year. The seller has owned the property since January 1. What is the seller's prorated share?
On a closing statement, the purchase price is recorded as: