7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- A closing statement shows debits (what a party owes) and credits (what a party receives) for both buyer and seller.
- The purchase price is a debit to the buyer and a credit to the seller; earnest money and the new loan are credits to the buyer only.
- Prorations divide shared expenses as of the closing date; the convention (day of closing to buyer or seller) and 360- vs. 365-day year affect the math.
- Accrued items (unpaid by seller, like arrears taxes) become a seller debit/buyer credit; prepaid items become a seller credit/buyer debit.
- Always confirm whether the day of closing is charged to the buyer or seller before computing a proration.
Settlement and the closing statement
At settlement (closing) title transfers and funds change hands. The closing statement reconciles every dollar using debits (charges a party owes) and credits (amounts a party receives). The buyer's debits minus credits equal cash the buyer must bring; the seller's credits minus debits equal proceeds the seller receives.
Core entries to memorize
| Item | Buyer | Seller |
|---|---|---|
| Sales price | Debit | Credit |
| Earnest money deposit | Credit | (none) |
| New mortgage loan | Credit | (none) |
| Seller's existing loan payoff | (none) | Debit |
| Unpaid (accrued) taxes | Credit | Debit |
The sales price is the buyer's largest debit and the seller's largest credit. Earnest money already on deposit is a buyer credit (the buyer gets it applied toward what they owe). The new loan is a buyer credit because the lender supplies those funds at closing. The seller's existing loan payoff is a seller debit because it reduces proceeds.
Customary cost splits vary by region and contract, but typically the seller pays the brokerage commission and owner's title costs while the buyer pays loan origination, appraisal, and recording of the deed/mortgage. Always defer to the contract.
Prorations
A proration fairly divides a recurring expense between buyer and seller as of the closing date. Steps:
- Find the annual (or monthly) amount of the item.
- Determine the per-day rate (360-day banker's year or 365-day calendar year, per the problem).
- Count the number of days each party is responsible for.
- Apply as a debit/credit. Accrued (seller used but not yet paid, e.g., taxes in arrears) = seller debit, buyer credit. Prepaid (seller paid ahead) = seller credit, buyer debit.
Worked example - taxes in arrears, 360-day method
Annual property tax is $3,600, unpaid, and closing is on May 31 (seller responsible through the day of closing). Use a 30-day month / 360-day year.
- Daily rate = $3,600 / 360 = $10/day.
- Seller owns Jan 1 through May 31 = 5 months x 30 days = 150 days.
- Seller's share = 150 x $10 = $1,500.
Because the taxes are unpaid (accrued), the $1,500 is a debit to the seller and a credit to the buyer - the buyer will pay the full bill later but is reimbursed at closing for the seller's portion.
Watch-outs
- Confirm whether the day of closing is charged to buyer or seller; it shifts the count by one day.
- 360-day vs. 365-day year changes the daily rate - read the question.
- Prepaid items (e.g., HOA dues, fuel oil, prepaid insurance) reverse the debit/credit direction versus arrears taxes.
Worked example - prepaid item
The seller prepaid annual HOA dues of $1,200 covering the full year, and closing is on September 30 using a 360-day year (seller responsible through closing). The seller has used 9 months x 30 = 270 days; the buyer will benefit from the remaining 90 days. Daily rate = $1,200 / 360 = $3.33/day. The buyer's reimbursable portion = 90 x $3.33 = $300. Because the seller paid ahead, this $300 is a credit to the seller and a debit to the buyer - the buyer repays the seller for coverage the buyer will enjoy.
RESPA and the closing statement
The Closing Disclosure is the modern settlement statement for most residential mortgage transactions, replacing the older HUD-1. It itemizes loan terms, projected payments, and the full cost breakdown for both parties. Cash transactions or commercial deals may still use a simpler settlement statement or an ALTA form. Either way, the debit-and-credit logic is identical, and the bottom line must balance: total buyer debits equal buyer credits plus cash to close, and the seller's net proceeds equal credits minus debits.
Reconciling the numbers
A reliable check: any item that is a debit to one party is frequently the mirror credit to the other when it is a transfer between them (sales price, prorations). Costs paid to third parties (recording fees, the appraiser, the title insurer) appear as a debit to whichever party owes them, with no offsetting entry on the other side. Keeping these two categories straight - transfers versus outside costs - prevents the most common closing-statement errors on the exam.
A full buyer's cash-to-close walkthrough
Tie the debit/credit logic together by computing what a buyer must bring. The cash to close equals the buyer's total debits minus total credits. Build it from the core entries: the sales price is the buyer's largest debit; the new loan and any earnest money already deposited are credits; closing costs the buyer owes (origination, appraisal, recording) are debits; and accrued taxes the seller owes are a buyer credit (offset by a seller debit).
Worked cash-to-close: Price $300,000 (buyer debit). New loan $240,000 (credit). Earnest money $6,000 (credit). Buyer's closing costs $4,500 (debit). Seller's unpaid taxes prorated to the buyer = $1,800 (buyer credit). Buyer debits = $300,000 + $4,500 = $304,500. Buyer credits = $240,000 + $6,000 + $1,800 = $247,800. Cash to close = $304,500 − $247,800 = $56,700.
Mirror-entry check (365-day proration): For the quiz scenario, annual taxes $4,380 on a 365-day year give a daily rate of $4,380 ÷ 365 = $12/day. With the seller responsible through the 90th day, the seller owes 90 × $12 = $1,080. Because the taxes are unpaid (in arrears), that $1,080 is a seller debit and buyer credit — the buyer will pay the full bill later and is reimbursed now. The discipline to memorize: a transfer between the parties (price, prorations) is a debit to one and a credit to the other, while a cost paid to a third party (the appraiser, the recorder) is a one-sided debit with no offset.
Annual property taxes of $4,380 are unpaid (in arrears). Closing occurs on the 90th day of the year, with the seller responsible through the day of closing, using a 365-day year. How is the seller's share entered?
On a closing statement, how are the sales price and the buyer's new mortgage loan recorded?