7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- On the closing statement a debit charges a party and a credit favors them; the sale price is a buyer debit and seller credit.
- Earnest money already paid and the new loan amount are both buyer credits, reducing cash needed at closing.
- Taxes paid in arrears (unpaid) are a seller debit and buyer credit; prepaid items are a seller credit and buyer debit.
- Prorate using the specified year (commonly a 360-day banker's year) and follow the stated day-of-closing convention.
- Net-to-seller problems divide by (1 - commission rate); never multiply the desired net by 1 plus the rate.
Settlement, Closing Statements, and Prorations
Closing is where the contract becomes ownership. The exam tests who pays what, how items are credited or debited on the Closing Disclosure, and how to prorate shared expenses between buyer and seller. Math here is reliably tested, so master the debit/credit logic.
Debits and credits
Each party has a column. A debit is a charge against (money owed by) the party; a credit is money in that party's favor.
- Seller credits: sale price (the big one).
- Seller debits: payoff of existing loan, broker commission, owner's title policy (custom-dependent), seller-paid prorations.
- Buyer debits: purchase price, recording fees, lender charges, prepaid interest.
- Buyer credits: earnest money already paid, new loan amount, seller concessions.
The sale price is a debit to the buyer and a credit to the seller - the most fundamental entry.
Earnest money and loan amounts
Earnest money the buyer already deposited appears as a buyer credit (it reduces what the buyer must bring to closing). The new loan amount is also a buyer credit, since the lender funds it on the buyer's behalf.
Proration basics
Proration divides a continuing expense between seller and buyer based on who owns the property during the period. The exam usually uses a 360-day banker's year (12 months x 30 days) unless told to use a 365-day actual year.
- Accrued (arrears) items (e.g., property taxes paid in arrears): the seller owes for days they owned but have not paid - this is a seller debit / buyer credit.
- Prepaid items (e.g., taxes or insurance paid ahead, or in some places HOA dues): the seller already paid past the closing date - this is a seller credit / buyer debit.
The seller typically owns the day of closing unless the contract says otherwise (memorize the convention your exam specifies).
Worked proration: property taxes
Annual tax = $3,600. Using a 360-day year, daily rate = $3,600 / 360 = $10/day. Monthly = $300. Closing is June 15; taxes are paid in arrears (unpaid for the year).
Seller owned Jan 1 through June 15 = 5 months + 15 days = 150 + 15 = 165 days. Seller's share = 165 x $10 = $1,650. Because taxes are in arrears and unpaid, this is a debit to the seller and a credit to the buyer of $1,650 (the buyer will pay the full bill later).
Worked proration: prepaid insurance assumption
If instead the seller had prepaid a $1,200 annual premium and closing is at the 9-month point, the seller used 9 months ($900) and 3 months ($300) remain. The buyer benefits from the remaining coverage, so $300 is a seller credit / buyer debit.
Settlement statement check figures
| Item | Buyer | Seller |
|---|---|---|
| Sale price | Debit | Credit |
| Earnest money deposit | Credit | - |
| New loan amount | Credit | - |
| Existing loan payoff | - | Debit |
| Broker commission | - | Debit |
| Taxes in arrears (unpaid) | Credit | Debit |
Commission and net-to-seller math
Commission example: $325,000 sale at 6% = $19,500 total, a seller debit. If the listing and selling brokers split 50/50, each office receives $9,750.
Net-to-seller (seller's-eyes) trap: A seller wants $200,000 net after a 6% commission. Do not multiply $200,000 by 1.06. Divide: $200,000 / (1 - 0.06) = $200,000 / 0.94 = $212,766 (rounded). At that price, 6% commission = $12,766, leaving the seller exactly $200,000.
Title, escrow, and the closing process
Closings happen through an escrow or settlement agent (title company, attorney, or escrow officer depending on the state) who holds funds and documents until all conditions are met, then disburses. The agent records the deed and security instrument and issues the final settlement statement.
- Title insurance protects against title defects: an owner's policy protects the buyer; a lender's (mortgagee) policy protects the lender for the loan amount.
- A survey confirms boundaries; a walk-through verifies condition before funding.
Items that do not prorate
Not every charge is shared. One-time costs belong entirely to one party: the buyer's recording fee for the deed, the lender's origination charges, and the seller's loan payoff. Only continuing, time-based expenses - taxes, interest, insurance, rents, and some HOA dues - prorate across the closing date.
Worked proration: rent on income property
A closing occurs June 10 on a rental that collects $1,500/month in rent the seller already received for June. Using a 30-day month, daily rent = $50. The buyer owns June 11-30 = 20 days, so the buyer is owed 20 x $50 = $1,000. Because the seller holds rent for days the buyer will own, this is a seller debit / buyer credit of $1,000.
Reconciling the bottom line
The statement balances when the buyer's total debits minus credits equals the cash the buyer must bring, and the seller's credits minus debits equals the seller's net proceeds. A quick exam check: if the sale price is the only large seller credit and the payoff plus commission are the major debits, the seller's net should fall well below the price.
Common traps
- Counting the day of closing to the wrong party - follow the stated convention.
- Multiplying instead of dividing on net-to-seller problems.
- Forgetting that the new loan and earnest money are buyer credits, not debits.
- Using 365 days when the question specifies a 360-day banker's year (or vice versa).
- Prorating a one-time fee (like recording or origination) that should be charged entirely to one party.
Annual property taxes are $4,320, paid in arrears and still unpaid. Closing is on July 1 using a 360-day year with the seller responsible through the day before closing (Jan 1-June 30 = 180 days). How is the seller's share entered?
A seller wants to net $235,000 after paying a 6% brokerage commission and no other costs. What sale price achieves this?