7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- At closing the buyer signs the note and security instrument; the seller signs and delivers the deed; recording the deed gives constructive notice and sets lien priority.
- On a settlement statement, a debit is a charge owed by a party and a credit is an amount in that party's favor; the purchase price is a debit to the buyer and a credit to the seller.
- Prepaid expenses (like prepaid taxes) and accrued expenses (like unpaid taxes) are prorated as of the closing date so each party pays only for the days they own the property.
- Title insurance protects against undiscovered title defects; the lender's policy protects the lender, and a separate owner's policy protects the buyer.
- Earnest money and seller credits appear as credits to the buyer; loan payoff and most settlement fees appear as debits to the appropriate party.
Who Signs What
Closing is where documents are signed, funds disbursed, and title transferred.
Table: Key Closing Documents
| Document | Purpose | Signer |
|---|---|---|
| Promissory note | Creates the debt | Buyer/borrower |
| Mortgage or deed of trust | Secures the loan with a lien | Buyer/borrower |
| Deed | Transfers legal title | Seller/grantor |
| Closing Disclosure | Final loan terms and costs | Buyer acknowledges |
Escrow, Title, and Recording
The escrow or closing agent is a neutral party that holds funds and documents until all conditions are met, then disburses. The title company runs the title search, issues the title commitment, and provides title insurance. Recording the deed in the public records gives constructive notice to the world and establishes lien priority (generally first to record, first in right).
Debits and Credits
A settlement statement balances each party's debits (charges owed) against credits (amounts in their favor).
Table: Common Entries
| Item | Buyer | Seller |
|---|---|---|
| Purchase price | Debit | Credit |
| Earnest money deposit | Credit | — |
| New loan proceeds | Credit | — |
| Existing loan payoff | — | Debit |
| Seller-paid concession | Credit | Debit |
| Owner's title policy (seller pays) | — | Debit |
The purchase price is a debit to the buyer (they owe it) and a credit to the seller (they receive it). Earnest money already paid is a credit to the buyer because it reduces cash still due at the table.
Prorations: The 360-Day Method
Prorations split ongoing expenses by ownership days so each party pays only their share. The statutory (banker's) method uses a 360-day year and 30-day months; the actual-days method uses the real calendar. Always read which the question specifies.
Worked Example: Prepaid Taxes
Annual taxes of $3,600 are paid in full by the seller on January 1. Closing is April 1 (banker's method). The seller used Jan, Feb, Mar = 3 months = 90 days. Daily rate = $3,600 ÷ 360 = $10/day.
- Buyer's share (Apr 1-Dec 31 = 9 months = 270 days): 270 × $10 = $2,700.
- Because the seller prepaid, the buyer reimburses the seller: credit seller $2,700, debit buyer $2,700.
Prorations: Accrued Items and Rent
Accrued (Unpaid) Taxes
If taxes are paid in arrears and are unpaid at closing, the seller owes for the days they owned. That is a debit to the seller and a credit to the buyer, who will pay the full bill later.
Rent on Income Property
Rent collected in advance for the closing month belongs partly to the buyer for the days after closing. The unearned portion is a credit to the buyer, debit to the seller.
Worked Example
Monthly rent is $1,500, collected by the seller on the 1st; closing is the 16th (30-day month). Buyer owns days 16-30 = 15 days. Daily rent = $1,500 ÷ 30 = $50. Buyer's share = 15 × $50 = $750, credited to the buyer and debited to the seller.
Title Insurance
A lender's policy protects the lender up to the loan balance; an owner's policy protects the buyer's equity. Title insurance covers undiscovered past defects, not future events, and does not replace the title search.
Single-Entry vs. Double-Entry Items
Every dollar at closing is either a single-entry item (charged to one party only) or a double-entry item (a debit to one side and an offsetting credit to the other).
- Double-entry: the purchase price (debit buyer, credit seller) and any proration (one side's debit equals the other side's credit).
- Single-entry: a fee that only one party owes, such as the buyer's loan-origination fee or the seller's brokerage commission.
The balancing rule: the buyer's total debits minus credits equals the cash the buyer must bring; the seller's total credits minus debits equals the net proceeds to the seller.
Worked Example: Buyer Cash to Close
Price $300,000 (debit buyer). New loan $240,000 (credit buyer). Earnest money $5,000 (credit buyer). Buyer closing costs $4,200 (debit buyer). Prepaid-tax reimbursement to seller $1,800 (debit buyer).
- Total debits = $300,000 + $4,200 + $1,800 = $306,000.
- Total credits = $240,000 + $5,000 = $245,000.
- Cash to close = $306,000 − $245,000 = $61,000.
Who Customarily Pays What
Who pays a given cost is often set by local custom or contract, but the exam tests typical defaults.
Table: Customary Cost Allocation
| Cost | Usually Paid By |
|---|---|
| Lender's title policy | Buyer (lender requires it) |
| Owner's title policy | Varies by region (often seller) |
| Loan origination / discount points | Buyer/borrower |
| Real estate commission | Seller |
| Recording the deed | Buyer |
| Recording the mortgage | Buyer |
| Transfer/realty transfer tax | Seller (in most states) |
| Survey | Negotiable |
Proration Direction: A Reliable Checklist
Misreading proration direction is the single most common closing-math error. Work it in three steps.
- Is the expense prepaid or accrued? Prepaid means the seller already paid past the closing date; accrued means the bill is unpaid and covers days the seller owned.
- Prepaid expense -> seller is owed money -> credit seller, debit buyer.
- Accrued expense -> seller owes for past days -> debit seller, credit buyer.
Worked Example: Accrued Taxes in Arrears
Annual taxes are $4,380 and unpaid; the jurisdiction bills in arrears. Closing is on day 100 of the year, using actual days. Daily rate = $4,380 ÷ 365 = $12/day. The seller owned 100 days, so the seller owes 100 × $12 = $1,200: debit the seller $1,200 and credit the buyer $1,200, because the buyer will pay the entire bill when it comes due.
RESPA and the Closing Disclosure at Settlement
The Closing Disclosure is the TRID form that itemizes the final debits and credits; it replaced the old HUD-1 for most consumer mortgage closings. The buyer must receive it at least three business days before consummation so the figures can be checked against the Loan Estimate. Cash-only and commercial deals fall outside TRID and may still use a HUD-1-style statement.
On the buyer's closing statement, the earnest money deposit already paid is shown as a:
Annual property taxes of $4,800 were prepaid by the seller on January 1. Using a 360-day year, closing occurs July 1. What is the buyer's reimbursement to the seller?