7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- On a closing statement, a debit is a charge (money owed) and a credit is money received or applied to a party's benefit.
- 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, recurring costs (taxes, interest, rent) between buyer and seller as of the closing date.
- Accrued items (owed but unpaid, like back taxes) are credited to the buyer and debited to the seller; prepaid items are credited to the seller.
- The 360-day banker's year (30-day months) is a common proration convention on the exam.
Reading a closing statement: debits and credits
At settlement the closing statement reconciles what each party owes and receives. Master one rule: a debit is a charge (money a party must pay or bring), and a credit is money a party receives or that is applied to their side.
Core entries:
| Item | Buyer | Seller |
|---|---|---|
| Sale price | Debit | Credit |
| Earnest money deposit | Credit | (already counted toward price) |
| New loan amount | Credit | — |
| Seller's payoff of existing loan | — | Debit |
| Broker commission (seller pays) | — | Debit |
The sale price is the biggest entry: it is a debit to the buyer (the buyer owes it) and a credit to the seller (the seller earns it). Earnest money already paid is a credit to the buyer because it reduces the cash the buyer must bring to closing. A new loan is a credit to the buyer because borrowed funds pay part of the price.
Prorations
Prorations split recurring costs fairly as of the closing date. Steps: (1) find the annual or monthly amount, (2) compute a daily rate, (3) multiply by the number of days each party is responsible. Many exams use the 360-day banker's year (each month = 30 days) unless told to use 365.
Accrued item (owed but unpaid): the seller used the property but has not paid (e.g., property taxes paid in arrears). The seller's share is a debit to the seller and a credit to the buyer, because the buyer will pay the full bill later.
Prepaid item: the seller paid in advance for time the buyer will benefit from; the seller is reimbursed — a credit to the seller and a debit to the buyer.
Worked proration: property taxes
Annual taxes = $3,600, unpaid (arrears). Closing is at the end of June 30 (seller owns Jan 1-Jun 30). Using a 360-day year: daily rate = 3,600 / 360 = $10/day. Seller's days = 6 months x 30 = 180 days. Seller's share = 180 x 10 = $1,800. Because taxes are unpaid, this $1,800 is debited to the seller, credited to the buyer.
Worked proration: rent collected in advance
Seller collected $1,500 monthly rent on June 1; closing June 16 (30-day month). The buyer owns days 16-30 = 15 days. Daily rent = 1,500 / 30 = $50. Buyer's share = 15 x 50 = $750, which is credited to the buyer and debited to the seller (seller holds rent for time the buyer owns).
Who customarily pays what
While contracts and local custom govern, the exam expects familiarity with typical allocations:
- Seller customarily pays: existing loan payoff, broker commission, owner's title policy (in many areas), seller's share of accrued taxes, deed preparation.
- Buyer customarily pays: loan origination and discount points, lender's title policy, appraisal and credit-report fees, recording the deed and new mortgage, prepaid escrow reserves and interest.
- Prorated and shared: property taxes, HOA dues, mortgage interest on an assumed loan, and rents on income property.
The 365-day method and interest prorations
Some exams require the actual (365-day) method. Daily rate = annual amount / 365, multiplied by exact days. Always read the question to see which convention is required; the same numbers produce different answers under 360 vs. 365.
Worked interest proration: a buyer's new loan closes June 10. Mortgage interest is paid in arrears, so the buyer prepays per diem interest from closing through month-end. Loan $200,000 at 6% annual: annual interest = 200,000 x 0.06 = $12,000. Daily (360-day) = 12,000 / 360 = $33.33. Days June 10-30 inclusive = 21 days. Prepaid interest = 21 x 33.33 = $700 (rounded), entered as a debit to the buyer.
Balancing the statement
A closing statement must balance: total buyer debits minus buyer credits equals the cash the buyer brings to closing; total seller credits minus seller debits equals the net proceeds to the seller. If a problem asks for "cash due from buyer," sum every buyer debit (price, costs, prepaids) and subtract every buyer credit (earnest money, new loan, accrued taxes credited to buyer). Methodically listing debits and credits prevents the most common settlement-math mistakes on exam day.
Worked Proration and Debit/Credit Direction
The two recurring tax customs are paid in arrears (the common case — taxes for the current year are not yet paid, so the seller owes their used portion) and prepaid (the seller already paid ahead, so the buyer reimburses the unused portion). Misreading the direction, not the arithmetic, is what sinks candidates.
Worked example (taxes in arrears, 360-day year): Annual taxes are $3,600; closing is June 15; taxes are unpaid. The seller owes Jan 1 through June 15 = 5 months and 15 days = 165 days. Daily rate = 3,600 ÷ 360 = $10/day. Seller's share = 165 × 10 = $1,650, entered as a debit to the seller and a credit to the buyer, because the buyer will pay the full bill later.
Worked example (prepaid insurance assumed): Seller prepaid a $1,200 annual policy the buyer takes over; closing July 1 leaves 6 months unused = $600. That is a credit to the seller, debit to the buyer. A debit to one party is not automatically a credit to the other — single-entry items like a recording fee debit only the responsible party.
Annual property taxes are $4,800, paid in arrears (unpaid at closing). Closing is at the end of March 31 using a 360-day year. What is the seller's prorated share and how is it entered?
On a closing statement, how is the earnest money deposit already paid by the buyer typically entered?