7.4 Settlement, Closing Statements, and Prorations

What happens at settlement

Settlement (closing) is the event where ownership transfers, funds change hands, and the buyer's loan funds. A settlement agent prepares a closing statement that accounts for every dollar. The core skill the exam tests is reading debits and credits: a debit is money a party owes (reduces what they take away or increases what they must bring); a credit is money in a party's favor.

Debits and credits cheat sheet

The purchase price is always a debit to the buyer and a credit to the seller. The buyer's earnest money and new loan are credits that reduce the cash the buyer must bring to closing.

Prorations — splitting shared costs by ownership

A proration divides a recurring expense or income (property taxes, HOA dues, prepaid rent, mortgage interest) between buyer and seller based on who owns the property each day. The party who used the period but has not paid is debited; the party who paid for time they will not own is credited.

Many exams use a statutory (banker's) year of 360 days with 30-day months unless told otherwise. Always note the closing-day convention the problem gives you (the seller usually owns the day of closing).

Worked proration example

Annual property taxes are $3,600, unpaid, with closing on April 30 using a 360-day year (the seller is responsible through closing).

1. Daily rate = $3,600 ÷ 360 = $10/day.
2. Seller's ownership = Jan, Feb, Mar, Apr = 4 months × 30 = 120 days.
3. Seller's share = 120 × $10 = $1,200.

Because the taxes are unpaid, the seller owes their share, so $1,200 is a debit to the seller and a credit to the buyer (the buyer will pay the full bill later).

Common closing costs and who pays

Typical buyer costs include loan origination fees, the appraisal, lender's title insurance, and recording the deed and mortgage. Typical seller costs include the brokerage commission, owner's title policy (in many regions), and transfer taxes (varies by location and contract). The exam often asks you to place a single cost on the correct side, so memorize the cheat-sheet pattern rather than every local custom.

Prepaid vs. arrears: which way the proration runs

The direction of a tax proration depends entirely on whether the cost was paid ahead (prepaid) or is paid after the period (in arrears). Reason it out instead of memorizing:

• Arrears (unpaid): the seller used the property but has not paid the bill, so the seller is debited their share and the buyer is credited (because the buyer will pay the full bill later). This is the most common convention on the exam.
• Prepaid: the seller paid for the whole period in advance but is leaving partway through, so the seller is credited for the unused days after closing and the buyer is debited (the buyer is reimbursing the seller for time the buyer will own).

The same logic applies to prepaid rent on an income property: the seller collected rent for the full month but owns only part of it, so the buyer is credited the portion covering days after closing and the seller is debited. Identify prepaid versus arrears first, then assign the debit and credit accordingly.

Balancing the statement and the bottom line

A closing statement balances when each party's debits and credits resolve to the cash they bring or receive. For the buyer, total debits (price plus prorated costs owed) minus total credits (earnest money plus new loan plus any seller credits) equals the cash to close the buyer must bring. For the seller, total credits (price plus prepaid items) minus total debits (loan payoff, commission, transfer tax, prorated arrears) equals the net proceeds the seller receives.

Mini-example: A seller's price credit is $300,000. Debits are a $180,000 loan payoff, an $18,000 commission, and a $1,200 tax proration in arrears. Net to seller = $300,000 - ($180,000 + $18,000 + $1,200) = $100,800. Reading the cheat-sheet pattern, applying the correct proration direction, and netting debits against credits lets you answer both the place-the-cost questions and the bottom-line cash questions in this section.

The settlement agent and the title work

At closing a neutral settlement (closing) agent coordinates the event: collecting funds, ensuring the deed and loan documents are properly signed and notarized, paying off the seller's existing loan, recording the new deed and mortgage, and disbursing the remaining proceeds. Depending on local custom, this role is filled by a title company, an attorney, or an escrow officer. The agent's job is to make sure no money is released until every condition is satisfied and the title is clear.

Before closing, a title search examines the public record to confirm the seller can convey marketable title, and a title commitment lists what must be cleared (existing liens, judgments, unpaid taxes) and what exceptions the policy will carry. The seller typically clears curable defects, such as paying off an old mechanic's lien, before or at closing.

Two title-insurance policies often issue at settlement: a lender's policy protecting the mortgagee up to the loan balance, and an owner's policy protecting the buyer's equity. The buyer usually pays for the lender's policy as a loan cost, while custom and the contract decide who pays for the owner's policy. Understanding the settlement agent's coordinating role and how title work feeds the closing statement explains why each debit and credit appears where it does.