7.4 Settlement, Closing Statements, and Prorations

Debits and credits, the closing grammar

At settlement, money is allocated between buyer and seller on a closing statement. Master the vocabulary:

• A debit is a charge — money a party must pay or bring.
• A credit is an amount in a party's favor — money they receive or already paid.

Key reciprocals you must memorize:

• Purchase price: debit to buyer (they owe it), credit to seller (they receive it).
• Earnest money deposit: credit to buyer only (already paid; reduces what they bring).
• New loan amount: credit to buyer (the lender pays this on the buyer's behalf).
• Seller's existing loan payoff: debit to seller (it comes out of their proceeds).

Single-entry vs. double-entry items

• A double-entry item appears on both sides as a reciprocal (e.g., purchase price = debit buyer, credit seller; prorated taxes adjust both).
• A single-entry item appears for only one party (e.g., the buyer's loan origination fee is a debit to the buyer only; the seller's brokerage commission is a debit to the seller only).

The broker's commission is almost always a debit to the seller in a typical listing. Recording the deed is usually a buyer charge; the release of the seller's mortgage is a seller charge. Always ask: who benefits, and who agreed to pay?

Proration mechanics

Prorations split shared, recurring costs (property taxes, HOA dues, prepaid rent, interest) as of the closing date. Two conventions appear:

• Statutory/banker's year: 360 days, 30-day months. Easier math, common on exams.
• Calendar year: 365 days, actual days.

Default exam steps:

1. Find the annual (or monthly) amount.
2. Divide to a daily rate.
3. Multiply by the number of days owed by the responsible party.

The big rule: items paid in arrears (like most property taxes) mean the seller owes (credit buyer) for the time they owned the property; items paid in advance (like HOA dues or prepaid insurance the buyer assumes) mean the buyer reimburses the seller (debit buyer).

Worked proration: taxes paid in arrears

Annual property tax = $3,600, unpaid, closing on April 1, using a 360-day year. The seller owned January, February, and March = 3 months = 90 days.

• Daily rate = $3,600 / 360 = $10/day.
• Seller's share = 90 days x $10 = $900.

Because taxes are paid in arrears and the buyer will pay the full bill later, the $900 is a credit to the buyer and a debit to the seller.

Reverse case (paid in advance): if the seller prepaid a $1,200 annual HOA fee and closing is at exactly 6 months remaining, the buyer reimburses $600 as a debit to buyer, credit to seller.

Settlement roles and final checks

• The settlement agent (title company, escrow officer, or attorney depending on the state) prepares the statement and disburses funds.
• RESPA/TRID govern the residential Closing Disclosure; the seller may receive a separate version.
• The deed is delivered and recorded; recording gives constructive notice and protects priority.

Final sanity checks for exam problems:

The buyer's cash to close = total buyer debits minus total buyer credits.

Seller's net proceeds and closing costs

The mirror of the buyer's cash to close is the seller's net proceeds = total seller credits (mainly the purchase price) minus total seller debits (loan payoff, commission, prorated arrears taxes, transfer charges they agreed to pay).

Worked example: a seller sells for $320,000, pays off a $180,000 loan, owes a 6% commission ($19,200), and owes a $900 tax proration. Net proceeds = $320,000 - $180,000 - $19,200 - $900 = $119,900 before minor fees.

Typical cost allocation, though always negotiable and state-influenced:

• Buyer commonly pays: loan origination and discount points, appraisal, credit report, recording the deed and mortgage, lender's title policy, prepaid interest, and escrow setup.
• Seller commonly pays: brokerage commission, owner's title policy in many areas, deed preparation, and the existing loan payoff and its release fee.

Common proration pitfalls and rent

Proration errors cost easy points, so watch these traps.

• Day of closing: contracts decide whether the closing day is charged to the buyer or seller. If the problem states a rule, follow it; otherwise the seller usually owns the closing day.
• Arrears vs. advance: misjudging direction flips the credit and debit. Property taxes are almost always arrears (seller owes the buyer); HOA dues paid up front are advance (buyer reimburses the seller).

Income property adds one more layer to watch:

• Rent on income property: rent the seller collected for the closing month is unearned for the buyer's days, so the seller credits the buyer the prorated remainder. Security deposits transfer in full as a credit to buyer / debit to seller.

Worked rent example: monthly rent $1,500 already collected, closing on the 16th of a 30-day month leaves 15 days for the buyer: $1,500 / 30 x 15 = $750 credited to the buyer and debited to the seller.