7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- On a settlement statement, a debit is money a party owes/pays and a credit is money a party receives; the sale price is a debit to the buyer and a credit to the seller.
- Prorations divide shared expenses (taxes, interest, HOA, rent) between buyer and seller as of the closing date.
- Items paid in arrears (like many property taxes) are usually a seller debit / buyer credit; items prepaid are reversed.
- Use the proper proration method (statutory 360-day/30-day month vs. exact 365-day) as directed by the problem.
- Earnest money already deposited is a credit to the buyer; the existing loan payoff is a debit to the seller.
Debits and credits
A settlement statement balances each party separately. The vocabulary trips people up:
- Debit = a charge against a party (money they pay or that reduces what they receive).
- Credit = money in favor of a party (money they bring in or receive).
| Item | Buyer | Seller |
|---|---|---|
| Sale price | Debit | Credit |
| Earnest money deposit | Credit | — |
| New loan amount | Credit | — |
| Seller's existing loan payoff | — | Debit |
| Brokerage commission | — | Debit (usually) |
The sale price is the biggest entry: a buyer debit (they owe it) and a seller credit (they receive it).
What prorations are
Shared, time-based expenses must be split so each party pays only for the days they own the property. Common prorated items: property taxes, mortgage interest, HOA dues, prepaid insurance, and rents.
- Paid in arrears (after the fact — typical of many property taxes): the seller has used the time but not paid, so the seller gets a debit and the buyer gets a credit for the seller's share.
- Prepaid (paid in advance — e.g., HOA dues, some insurance): the seller already paid beyond closing, so the seller gets a credit and the buyer a debit.
Convention: Unless told otherwise, the seller owns the day of closing on many exams — read the question's instruction.
Proration methods
- Statutory / banker's method: 360-day year, 30-day months. Simplest for hand calculation.
- Exact / actual method: 365-day year (366 in leap year), actual days in each month. More precise.
Always follow the method the question specifies. If it is silent, the 360/30 method is the common exam default unless stated.
Worked proration #1 — taxes paid in arrears (360-day method)
Annual taxes are $3,600, unpaid, and closing is on April 30 (seller owns through April 30; assume Jan 1 start).
- Daily rate = $3,600 / 360 = $10/day.
- Seller's ownership: Jan, Feb, Mar, Apr = 4 months × 30 = 120 days.
- Seller's share = 120 × $10 = $1,200.
- Because taxes are paid in arrears, this $1,200 is a seller debit and a buyer credit (the buyer will pay the full bill later and is reimbursed now).
Worked proration #2 — prepaid HOA dues (360-day method)
The seller prepaid $240 in annual HOA dues for the calendar year; closing is on March 31 (seller owns Jan–Mar = 90 days).
- Daily rate = $240 / 360 = $0.6667/day (≈ $20/month).
- Days the buyer will own but seller already paid = 360 − 90 = 270 days.
- Buyer's share = 270 × $0.6667 = $180.
- Because it was prepaid, the seller gets a $180 credit and the buyer a $180 debit.
Worked proration #3 — interim interest: A new loan of $200,000 at 6% closes June 20; the first payment is Aug 1, so the buyer prepays interest for the remaining days of June. Daily interest = ($200,000 × 0.06) / 360 = $33.33/day. June 20–30 inclusive = 11 days → $33.33 × 11 = $366.63 buyer debit (prepaid interest).
Common closing costs and who pays
Who pays which fee is partly law and partly local custom and negotiation, but the exam expects the typical pattern:
| Cost | Usually paid by |
|---|---|
| Brokerage commission | Seller |
| Owner's title insurance | Often seller (varies) |
| Lender's title insurance | Buyer |
| Loan origination / discount points | Buyer |
| Appraisal & credit report | Buyer |
| Recording the deed | Buyer |
| Recording satisfaction of seller's loan | Seller |
| Transfer / documentary taxes | Varies by state custom |
Trap: A title-insurance policy protecting the lender benefits only the lender for the loan amount; the buyer needs a separate owner's policy to be protected for their equity.
Balancing the statement and the broker's role
Every settlement statement must balance: the buyer's total debits minus total credits equals the cash the buyer must bring to closing, and the seller's total credits minus total debits equals the net proceeds the seller receives. The closing/settlement agent (title company, attorney, or escrow officer depending on the state) prepares it; under TRID the lender is responsible for the borrower's Closing Disclosure.
Real-estate agents should be able to estimate net-to-seller and cash-to-close for their clients but must not practice law or guarantee figures. A frequent test scenario: given a sale price, payoff, commission, and prorations, compute the seller's net. Work top-down — start with the price (seller credit), subtract the payoff, commission, and any seller-debit prorations to reach net proceeds.
Debit/credit logic on the settlement statement
A closing statement is a balance sheet: each party has debits (amounts they owe) and credits (amounts in their favor). The skill the exam tests is placing an item on the correct side.
| Item | Buyer | Seller |
|---|---|---|
| Purchase price | Debit | Credit |
| Earnest money already paid | Credit | — |
| New loan proceeds | Credit | — |
| Seller's mortgage payoff | — | Debit |
| Unpaid (accrued) taxes at closing | Credit | Debit |
| Seller-prepaid item (insurance) | Debit | Credit |
The purchase price is the buyer's largest debit and the seller's largest credit. The earnest money is a buyer credit because it was already paid toward the price. Mastering this grid lets you answer "who pays / who is credited" items without redoing the full statement.
Worked proration and the 365- vs. 360-day choice
Closing is April 15; annual taxes of $3,650 are unpaid. Using the actual-day (365) method, the daily rate = $3,650 ÷ 365 = $10/day. The seller owned Jan 1–Apr 15 = 31+28+31+15 = 105 days, so the seller's accrued share = 105 x $10 = $1,050, entered as a seller debit / buyer credit (the buyer will pay the full bill later).
The banker's 360-day method would instead give $3,650 ÷ 360 = $10.139/day x (3 months x 30 + 15 = 105 days) = $1,064.58 — a different answer. The exam tip: read which day-count the question specifies; mixing 365 and 360 is the most common proration error, and an unpaid item always debits the seller while a prepaid item credits the seller for the unused portion.
Annual property taxes of $4,800 are paid in arrears and remain unpaid at closing on June 30 (seller owns Jan 1 through June 30). Using the 360-day method, how is the seller's share handled?
On a buyer's closing statement, which of the following is recorded as a CREDIT to the buyer?