7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- On a closing statement a debit is money a party owes; a credit is money a party receives.
- Purchase price = debit buyer / credit seller; earnest money and the new loan = credits to the buyer.
- Accrued, unpaid items (taxes in arrears) credit the buyer and debit the seller; prepaid items debit the buyer and credit the seller.
- Prorations depend on whether a 360-day (banker's) or 365-day year is used and who owns the closing day.
- Compute a daily or monthly rate first, multiply by the responsible party's period, then post offsetting debit/credit entries.
What Happens at Settlement
Settlement (closing) is when ownership transfers, the loan funds, and money is disbursed. A closing statement (the Closing Disclosure on most consumer loans) accounts for every dollar.
Entries are recorded as debits (charges) and credits (amounts owed to a party):
- A debit to a party is money that party must pay.
- A credit to a party is money that party receives or is credited.
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. Always ask: does this item cost the party (debit) or benefit the party (credit)?
Who Pays What — Common Entries
Unless the contract says otherwise, typical allocations are:
| Item | Buyer | Seller |
|---|---|---|
| Purchase price | Debit | Credit |
| Earnest money deposit | Credit | — |
| New loan amount | Credit | — |
| Seller's loan payoff | — | Debit |
| Unpaid property taxes (accrued) | Credit | Debit |
| Prepaid taxes (seller paid ahead) | Debit | Credit |
| Owner's title / deed prep (often) | — | Debit |
The new loan is a credit to the buyer because it supplies funds toward the price. The seller's existing mortgage payoff is a debit to the seller because it reduces their proceeds.
Prorations: Splitting Shared Costs
Proration divides ongoing costs (taxes, HOA dues, prepaid rent, interest) fairly between buyer and seller as of the closing date. Two key choices drive the math:
- Statutory/banker's year (360 days, 30-day months) vs. calendar year (365 days) — the exam tells you which to use.
- Who owns the closing day — typically the seller owns the day of closing, but the contract controls.
For accrued, unpaid items (e.g., taxes paid in arrears), the seller owes their share up to closing: it is a credit to the buyer / debit to the seller. For prepaid items, the seller is reimbursed: a debit to the buyer / credit to the seller.
Worked Proration — Taxes in Arrears
Annual property taxes are $3,600, unpaid, and closing is on the last day of April. Use a 360-day (banker's) year; the seller owns the closing day.
- Daily rate = $3,600 / 360 = $10/day
- Monthly amount = $3,600 / 12 = $300/month
- Seller's period = January through April = 4 full months = 4 × $300 = $1,200
Because taxes are unpaid (the buyer will pay the full bill later), the seller owes their $1,200 share now:
- Credit to buyer: $1,200
- Debit to seller: $1,200
If the problem used a calendar year, the daily rate would be $3,600 / 365 = $9.863/day, and you would count actual days.
Worked Proration — Prepaid Item
The seller prepaid an annual HOA assessment of $1,200 on January 1, and closing is June 30 (end of the 6th month). Use a 360-day year; seller owns the closing day.
- Monthly amount = $1,200 / 12 = $100/month
- Seller used January through June = 6 months × $100 = $600
- Buyer's share (July–December) = 6 months × $100 = $600
The seller paid ahead for time the buyer will enjoy, so the buyer reimburses the seller:
- Debit to buyer: $600
- Credit to seller: $600
Reconciliation tip: a balanced statement has total buyer debits equal to buyer credits plus cash due, and the proration entries always appear as offsetting debit/credit pairs.
Closing Costs, RESPA at Settlement, and Computing Cash to Close
Closing costs split into recurring charges (prepaid interest, escrow deposits for taxes and insurance) and non-recurring charges (origination fees, appraisal, title, recording). The contract and custom decide who pays each.
To find the buyer's cash to close, total all buyer debits and subtract all buyer credits:
- Purchase price $300,000 (debit) + closing costs $6,000 (debit) + prepaid item reimbursing seller $600 (debit) = $306,600 total debits
- New loan $240,000 (credit) + earnest money $5,000 (credit) + tax proration $1,200 (credit) = $246,200 total credits
- Cash to close = $306,600 − $246,200 = $60,400
The seller's net mirrors this: start with the price as a credit, then subtract loan payoff, commission, and the seller's debits. Because RESPA-covered loans now use the Closing Disclosure, the agent should reconcile it against the contract before closing day and confirm the figures match the Loan Estimate within tolerance.
Seller's net proceeds, transfer tax, and a calendar-day proration
Beyond the buyer's cash to close, expect to compute the seller's net proceeds: start with the sale price as a credit, then subtract the loan payoff, brokerage commission, the seller's share of prorated items, transfer taxes if customarily seller-paid, and any seller-paid closing costs.
Worked seller's net: sale price $300,000; existing loan payoff $180,000; commission 6% of price = $18,000; seller's tax proration owed (credited to buyer) $1,200; seller-paid title and recording $1,500. Net = $300,000 − $180,000 − $18,000 − $1,200 − $1,500 = $99,300. Notice the commission is computed on the full price, not on the equity.
Transfer (conveyance) taxes are charged by many states and counties on the recorded deed, often as a rate per $500 or $1,000 of price, and are typically a seller debit. Worked transfer tax: a $250,000 sale in a county charging $1 per $1,000 = $250,000 / 1,000 × $1 = $250 transfer tax, debited to the seller.
A calendar-year proration sharpens the math when the problem demands actual days. Annual taxes of $3,650 are unpaid; closing is on March 31 with the seller owning the closing day, using a 365-day year. Daily rate = $3,650 / 365 = $10/day. The seller owns Jan 1 through Mar 31 = 31 + 28 + 31 = 90 days. Seller's accrued share = 90 × $10 = $900, entered as a credit to the buyer and debit to the seller because the taxes are unpaid and the buyer will pay the full bill later.
Always confirm whether the problem wants the 360-day banker's year or the 365-day calendar year — they produce different daily rates and the question will tell you which to use.
At closing, the buyer obtains a new mortgage loan to help fund the purchase. On the closing statement, the new loan amount is recorded as:
Annual taxes of $4,320 are unpaid and closing is at the end of March. Using a 360-day year with the seller owning the closing day, how is the seller's share handled?