7.4 Settlement, Closing Statements, and Prorations

Debits, Credits, and the Settlement Statement

At closing, a settlement statement reconciles what each party owes and receives. The single most tested concept is debit vs. credit:

• A debit is a charge to a party (money they must pay or have already received credit for).
• A credit is money in favor of a party.

The sales price is a debit to the buyer (they owe it) and a credit to the seller (they receive it). The buyer's loan amount is a credit to the buyer (it pays part of the price). Earnest money already deposited is a credit to the buyer. The seller's existing loan payoff is a debit to the seller.

Double-entry items (one party's debit is the other's credit) include the sales price and prorated taxes; single-entry items (charge to one side only) include each party's own loan or recording fees.

Proration Basics

Proration splits a shared expense between buyer and seller as of the closing date. The exam usually uses either:

• Statutory/banker's year: 360 days, 30-day months (simpler math), or
• Actual (365-day) year with actual days in the month.

First decide whether the item is paid in arrears (after the period, e.g., most property taxes) or paid in advance (before, e.g., insurance, some HOA dues):

• Arrears, seller pays at closing: the seller owes their share up to (and often including) closing day -> debit seller, credit buyer because the buyer will pay the full bill later.
• Advance, seller prepaid: the buyer reimburses the seller for the unused portion -> debit buyer, credit seller.

Worked Proration (Taxes in Arrears, 360-Day Method)

Annual property tax = $3,600. Closing date = April 30. Taxes are paid in arrears, and the seller is responsible through the day of closing.

1. Daily rate = $3,600 ÷ 360 = $10/day.
2. Months elapsed Jan–Apr = 4 months × 30 days = 120 days (seller owns through April 30).
3. Seller's share = 120 × $10 = $1,200.

Result: $1,200 is a debit to the seller and a credit to the buyer, because the buyer will eventually pay the entire annual bill and must be reimbursed for the seller's portion.

Check logic: if the proration is to the seller's disadvantage (they used the service), the seller is debited.

Worked Proration (Insurance Paid in Advance)

Seller prepaid a 1-year hazard policy of $1,200 that runs to December 31. Closing is September 1 (actual-day method here for contrast). Days remaining Sep 1–Dec 31 = 30 + 31 + 30 + 31 = 122 days of coverage the buyer benefits from.

• Daily rate = $1,200 ÷ 365 = $3.288/day.
• Buyer reimburses seller = 122 × $3.288 ≈ $401.10.
• This is a debit to the buyer, credit to the seller.

Final sanity rules for the exam:

• Sales price: debit buyer / credit seller.
• New loan proceeds: credit buyer only.
• Earnest money: credit buyer only.
• Seller loan payoff: debit seller only.
• Prorated arrears tax: debit seller / credit buyer.
• Prepaid item: debit buyer / credit seller.

Balancing the Statement and Common Fees

A closing statement must balance: total debits to a party offset their credits, and the net tells you who brings cash or walks away with funds. The buyer's cash to close = total buyer debits − total buyer credits (price + buyer-paid costs, minus loan, earnest money, and any seller concessions). The seller's net proceeds = total seller credits − total seller debits (price minus payoff, commission, and prorated arrears items).

Typical fee assignment (negotiable but exam-standard):

Watch the wording: who customarily pays differs from who must pay, and the contract controls when it specifies.

The 'Day of Closing' Convention and Mid-Month Math

Exam prorations hinge on who owns the day of closing. A common convention gives the seller the day of closing (seller responsible through that day); some questions give it to the buyer. Read the stem carefully — a one-day difference changes the answer.

Mid-month worked example (360-day method): annual taxes $4,320, closing on the 15th of June, taxes in arrears, seller responsible through closing. Daily rate = $4,320 ÷ 360 = $12/day. Days Jan 1–June 15 = 5 full months (150 days) + 15 = 165 days. Seller's share = 165 × $12 = $1,980, entered as a debit to the seller, credit to the buyer. If the buyer instead owned the closing day, you would use 164 days. This precision is exactly what closing-math questions test.

Debits, Credits, and Who Pays What

A closing statement is a balance sheet of debits (charges) and credits (amounts to a party's benefit). Master the recurring entries:

Double-entry check: Every proration is a debit to one party and a credit to the other for the same dollar amount, so the statement balances. A common error is entering a proration only once.

Worked payoff plus proration: Sale price $250,000; seller's loan payoff $140,000; unpaid taxes of $3,650/year prorated to the seller for 200 days = $3,650 / 365 x 200 = $2,000 (debit seller, credit buyer); Nebraska stamp tax $2.25 per $1,000 = $562.50 (debit seller). Seller's gross proceeds before commission = $250,000 - $140,000 - $2,000 - $562.50 = $107,437.50, then less the brokerage commission.