7.4 Settlement, Closing Statements, and Prorations

Reading a closing statement

At settlement, money owed by and to each party is itemized as debits (charges) and credits (amounts in your favor). The exam tests who is debited and who is credited for each item.

Trap: the sales price is a debit to the buyer (they owe it) and a credit to the seller (they receive it). Earnest money is a buyer credit because it is applied toward what the buyer owes.

Proration basics

Proration divides a shared expense between buyer and seller as of the closing date. Items like property taxes, HOA dues, rent, and prepaid interest get split. Two conventions appear on the exam:

• Statutory/banker's year: 360 days, 30 days per month — simpler arithmetic.
• Actual/365-day year: uses the real number of days.

The rule of thumb: the seller owns the property through the day of closing on most exams (the seller is responsible for the closing day) — but always follow the convention the question states. Arrears items (paid after the period) versus prepaid items (paid in advance) flip who owes whom.

Worked proration — unpaid taxes (arrears)

Annual taxes are $3,600, unpaid, and closing is April 30 using a 360-day/30-day-month basis. Taxes are paid in arrears, so the seller owes for the time they owned the property (Jan–Apr).

1. Daily rate = $3,600 ÷ 360 = $10 per day.
2. Seller's ownership = January, February, March, April = 4 months × 30 days = 120 days.
3. Seller's share = 120 × $10 = $1,200.
4. Because taxes are unpaid, the seller is debited $1,200 and the buyer is credited $1,200 (the buyer will pay the full bill later and is reimbursed now).

Trap: in arrears, the seller pays their share to the buyer because the buyer ultimately pays the whole annual bill.

Worked proration — prepaid item and net to seller

Prepaid HOA example. The seller prepaid $600 of annual HOA dues; closing is July 1 (mid-year) on a 360-day basis. The seller used 6 months and prepaid the full year, so the buyer reimburses the unused half.

1. Daily rate = $600 ÷ 360 = $1.667.
2. Buyer's remaining days = July–December = 180 days.
3. Buyer reimbursement = 180 × $1.667 = $300. Buyer is debited $300, seller credited $300.

Net-to-seller math. Sales price $300,000; payoff $180,000; commission 6% = $18,000; seller's tax proration debit $1,200; other seller costs $2,000.

• Net = $300,000 − $180,000 − $18,000 − $1,200 − $2,000 = $98,800.

Work top-down: start with price, subtract every seller debit, add every seller credit.

Settlement roles, escrow, and required disclosures

Closing can be conducted at a table (table closing) or through an escrow in which a neutral agent holds funds and documents until every condition is met, then disburses. The settlement agent prepares the Closing Disclosure for the buyer-borrower and a seller's settlement statement, collects funds, records the deed and mortgage, and pays off existing liens.

Reserves matter too. Lenders typically establish an impound (escrow) account funding several months of taxes and insurance so those bills are paid when due; the buyer is debited for the initial deposit at closing.

Trap: recording is what gives constructive notice of the new ownership and lien. The deed transfers title when delivered and accepted, but recording protects the buyer's priority against later claims.

Closing costs allocation and a full reconciliation

Who pays which cost is often set by contract or local custom, but the exam expects defaults: the buyer usually pays loan-origination costs, appraisal, credit report, and recording of the mortgage; the seller usually pays the commission, owner's title policy in many areas, and the payoff of existing loans.

Reconciliation logic. A complete statement must balance: total buyer debits minus buyer credits equals the cash the buyer brings to closing; total seller credits minus seller debits equals the seller's net proceeds.

Always confirm earnest money sits as a buyer credit and that the new loan reduces the buyer's cash required.

Debit/Credit Quick Reference and a Cash-to-Close Walkthrough

Lock in who is debited and credited, then closing math becomes mechanical. A debit is a charge (money owed); a credit is money in that party's favor.

Cash-to-close walkthrough. Price $300,000; earnest money $9,000; new loan $240,000; buyer closing costs $4,000; tax proration credit to buyer $1,200.

• Buyer debits = $300,000 + $4,000 = $304,000.
• Buyer credits = $9,000 + $240,000 + $1,200 = $250,200.
• Cash to close = $304,000 − $250,200 = $53,800.

Always verify the new loan and earnest money sit on the credit side, reducing the buyer's cash requirement.