7.4 Settlement, Closing, and Prorations
Key Takeaways
- At closing, amounts owed appear as debits (charges) and credits (amounts received or to be received) for buyer and seller.
- The purchase price is a debit to the buyer and a credit to the seller; earnest money is a credit to the buyer.
- Prorations divide shared costs (taxes, HOA dues, prepaid items) between buyer and seller as of the closing date.
- Accrued, unpaid expenses are credited to the buyer and debited to the seller; prepaid expenses are credited to the seller and debited to the buyer.
- Use the 360-day banker's year or 365-day calendar year exactly as the exam question specifies.
Debits and Credits
A closing (settlement) statement lists every charge and credit for the buyer and the seller. A debit is an amount a party owes or pays; a credit is an amount a party receives or is given.
The purchase price is a debit to the buyer (they owe it) and a credit to the seller (they receive it). Earnest money already on deposit is a credit to the buyer, reducing what they must bring to closing. The new loan amount is also a credit to the buyer because it pays part of the price.
Items Charged to Each Party
Table: Typical Debits and Credits
| Item | Buyer | Seller |
|---|---|---|
| Purchase price | Debit | Credit |
| Earnest money deposit | Credit | (none) |
| New loan proceeds | Credit | (none) |
| Seller's loan payoff | (none) | Debit |
| Brokerage commission | (none) | Debit (usually) |
| Unpaid (accrued) taxes | Credit | Debit |
| Prepaid HOA dues | Debit | Credit |
Single-party costs simply debit the responsible party. Shared costs that span the closing date must be prorated.
Proration Rules
A proration divides a shared expense between buyer and seller based on the portion of the period each owns the property. The closing date itself is typically charged to the buyer unless the contract states otherwise.
- Accrued (unpaid) expenses - The seller used the service but has not paid (for example, property taxes paid in arrears). These are a credit to the buyer and a debit to the seller, because the seller owes their share.
- Prepaid expenses - The seller paid in advance for a period extending past closing (for example, prepaid HOA dues or insurance the buyer assumes). These are a credit to the seller and a debit to the buyer.
Exams use either a 360-day banker's year (30-day months) or a 365-day calendar year. Always read which method the question requires.
Worked Proration Example
Annual property taxes are $3,600, paid in arrears (unpaid for the current year). Closing is on July 1. Using a 360-day year:
- Daily tax = $3,600 / 360 = $10 per day
- Seller owned Jan 1 - June 30 = 180 days (the day of closing goes to the buyer)
- Seller's share = 180 x $10 = $1,800
Because taxes are accrued and unpaid, the $1,800 is a debit to the seller and a credit to the buyer. The buyer will later pay the full bill, so they receive credit for the seller's portion now.
If the same taxes had been prepaid by the seller for the whole year, the unused $1,800 would instead be a credit to the seller and a debit to the buyer.
A Second Proration: Mid-Month Closing
Proration questions rarely land on a clean month boundary. Practice a mid-month date using the 365-day method.
Worked Example
Annual taxes are $2,920, paid in arrears, closing September 16. Charge the closing day to the buyer, so the seller owns January 1 through September 15.
- Daily tax = $2,920 / 365 = $8.00 per day
- Seller's days = 31 (Jan) + 28 + 31 + 30 + 31 + 30 + 31 + 31 + 15 (Sep 1-15) = 258 days
- Seller's share = 258 x $8.00 = $2,064
Because taxes are accrued and unpaid, $2,064 is a debit to the seller, credit to the buyer. Watch the method: the same closing on a 360-day banker's year uses $2,920 / 360 = $8.111/day and 30-day months (8 x 30 + 15 = 255 days), giving 255 x $8.111 = $2,068.33 - a different answer, which is why the question always states the convention.
Exam Trap: Re-read whether the item is paid in arrears (most taxes) or prepaid (insurance, HOA). Arrears = debit seller; prepaid = credit seller. Reversing the direction is the single most common proration error.
Balancing the Statement and RESPA at Closing
The settlement statement must balance: the buyer's total debits minus total credits equals the cash the buyer brings to closing, and the seller's total credits minus total debits equals the net proceeds to the seller.
Worked Example
A buyer purchases at $300,000 with a $240,000 new loan and a $5,000 earnest-money deposit already on deposit, plus $4,000 of buyer-side closing costs.
- Buyer debits: $300,000 price + $4,000 costs = $304,000
- Buyer credits: $240,000 loan + $5,000 earnest money = $245,000
- Cash to close = $304,000 - $245,000 = $59,000
Recall from 7.3 that the buyer must receive the Closing Disclosure at least three business days before this settlement, letting them confirm these figures against the Loan Estimate. The licensee's role at closing is to make sure the numbers match the contract, deposits are accounted for, and required disclosures were delivered on time.
On the seller side of the same deal, suppose the seller's loan payoff is $150,000 and the commission is $18,000. The seller's net proceeds = $300,000 price (credit) - $150,000 payoff - $18,000 commission - the seller's share of prorated items = the cash the seller walks away with. A single dollar out of place means the statement does not balance, so closers reconcile both columns before funding. The agent does not prepare the statement (a settlement agent or title company does), but the agent should review it for the figures the agent negotiated.
Property taxes are paid in arrears and remain unpaid at closing. On the settlement statement, how is the seller's share of those taxes handled?
On a closing statement, the purchase price is recorded as: