7.4 Settlement, Closing Statements, and Prorations

What Happens at Closing

Settlement (closing) is where title transfers, the loan funds, and money changes hands. A settlement agent prepares a closing statement allocating costs between buyer and seller. For most consumer mortgages the Closing Disclosure (CD) is used; commercial and cash deals may still use a settlement statement modeled on the older HUD-1. The exam tests how items are entered: each charge is either a debit (a charge owed) or a credit (money to a party's benefit), and the buyer's and seller's columns mirror each other for shared items.

Debits and Credits Logic

Think of each side's statement as a balance sheet. A debit to the buyer increases the cash the buyer must bring; a credit to the buyer reduces it. The purchase price is a debit to the buyer and a credit to the seller. Earnest money already paid is a credit to the buyer. The buyer's new loan amount is a credit to the buyer (it covers part of the price). The seller's existing loan payoff is a debit to the seller. Brokerage commission is almost always a debit to the seller.

Common entries and where they land:

Prorations: The Big Calculation

Prorations split ongoing costs (taxes, HOA dues, rent, interest) fairly as of the closing date. Two conventions appear on exams. The statutory/banker's year uses 360 days (12 months of 30 days each); the actual/calendar year uses 365 days. Unless a question says otherwise, follow its stated method. The first question is always: who is responsible for the day of closing? Most state rules charge the seller through the day before closing (the buyer owns closing day), but follow the question's instruction.

Worked Tax Proration (Taxes in Arrears)

Annual taxes are $3,600, unpaid, and closing is April 1 using a 360-day year (each month = 30 days). Taxes are paid in arrears, so the seller owes for the time owned this year: January, February, March = 3 months.

• Daily rate = $3,600 / 360 = $10.00 per day
• Seller's share = 3 months x 30 days = 90 days x $10 = $900

Because the taxes are unpaid, the seller's $900 share is a debit to the seller and a credit to the buyer (the buyer will pay the full bill later and is reimbursed now).

Debit/credit logic you can apply to any line

A closing statement balances each party's debits (charges) and credits. Anchor on the recurring entries:

The price is always a debit to the buyer and a credit to the seller — that single anchor lets you reason out the rest.

Worked proration both directions

Taxes in arrears: Annual tax $3,600, closing May 1, 30-day months, seller owned Jan–Apr (120 days). Daily rate = 3,600 / 360 = $10. Seller's share = 120 x $10 = $1,200, entered as a debit to seller / credit to buyer because the seller used time not yet paid.

Prepaid item (HOA paid ahead): Seller prepaid $600 annual HOA on Jan 1; closing July 1 (180 days used, 180 days remain). Unused portion = 180 x ($600/360) = $300, entered as a credit to seller / debit to buyer because the buyer enjoys the prepaid balance.

Single-entry vs. double-entry and customary allocations

A double-entry item moves money between the parties (the price, prorations) and appears on both sides. A single-entry item is a one-party cost (the buyer's loan origination fee, the seller's broker commission) appearing once. Customary (and negotiable) allocations: the seller typically pays the commission and owner's title policy (varies by region); the buyer typically pays loan costs and recording of the deed/mortgage. RESPA's prohibition on unearned fees means no party may be charged for a service not actually performed.

Prepaid vs. Arrears Direction

Direction of the proration depends on whether the item is paid ahead or behind. In arrears (unpaid taxes): the seller used the service but has not paid, so the seller is debited and the buyer credited. Prepaid (seller paid an annual HOA fee or insurance in advance): the buyer benefits from the unused portion, so the buyer is debited and the seller credited. A reliable test trick: ask "who already paid, and who used the benefit?" The user who did not pay for their use owes the other party.

Reconciling the Statement

After all debits and credits are entered, total each party's columns. The buyer's required cash to close equals total buyer debits minus total buyer credits. The seller's net proceeds equals total seller credits minus total seller debits. A frequent trap is misplacing the new loan (it is a buyer credit, not a debit) or forgetting that an unpaid expense flows opposite to a prepaid one. Always confirm the method (360 vs. 365 days) and the closing-day responsibility before computing prorations.

Single-Entry vs. Double-Entry Items

Some closing items appear on only one side; others appear on both. A single-entry item, such as the brokerage commission (seller debit) or a buyer's loan origination fee (buyer debit), affects just one party. A double-entry item, such as a tax proration or the purchase price, shows as a debit on one side and a credit on the other. Recognizing which items are paired prevents the classic mistake of crediting one party without the offsetting debit. The settlement agent's reconciled statement must balance: total debits and credits across the transaction tie out to the funds disbursed.

Costs Customarily Allocated

Who pays what is partly custom and partly negotiated, but exams test typical defaults. The seller commonly pays the brokerage commission, owner's title policy in many regions, and a deed-preparation fee. The buyer typically pays loan-related costs (origination, appraisal, credit report), recording the deed and mortgage, and the lender's title policy. Recurring items like property taxes, HOA dues, and prepaid interest are prorated between them. Transfer taxes vary by jurisdiction. When a question states an allocation, follow it; when silent, apply the customary split described here.