7.4 Settlement, Closing Statements, and Prorations
Key Takeaways
- A closing statement lists debits and credits for buyer and seller; the buyer's debits drive cash needed to close.
- A debit is a charge owed; a credit is money applied for that party's benefit.
- Prorations divide shared expenses by who used the property; the 360-day banker's year is common on exams.
- Prepaid items (paid in advance) credit the seller; accrued/arrears items (unpaid) credit the buyer.
- Earnest money is a buyer credit; the new loan is a buyer credit; the sales price is a buyer debit and seller credit.
Debits and credits
A closing (settlement) statement reconciles all money in the transaction. For each party:
- A debit is a charge against that party (money they owe).
- A credit is money in that party's favor (money applied to them).
The buyer's total debits minus total credits = cash the buyer must bring to closing. The seller's total credits minus total debits = net proceeds.
| Item | Buyer | Seller |
|---|---|---|
| Sales price | Debit | Credit |
| Earnest money (deposit) | Credit | — |
| New loan amount | Credit | — |
| Seller's existing loan payoff | — | Debit |
| Broker commission | — | Debit (usually) |
| Prepaid taxes (seller paid ahead) | Debit | Credit |
| Accrued taxes (unpaid) | Credit | Debit |
The sales price is the buyer's largest debit and the seller's largest credit. Earnest money and the new loan are buyer credits because they reduce the cash the buyer must produce.
A helpful rule: an item that appears as a debit to one party does not automatically appear as a credit to the other. The sales price is a true mirror (buyer debit, seller credit), but most closing costs (recording fees, the buyer's loan origination charge, the buyer's title insurance) are single-entry debits charged only to the party who owes them. Earnest money is unusual — it is a buyer credit with no matching seller entry because the deposit is the buyer's own money already on account. Mislabeling a single-entry cost as a double entry is one of the most common math errors on the settlement portion of the exam.
Prorations: who used it pays for it
Proration splits a shared expense between buyer and seller based on the period each owns/uses the property. The closing date is the dividing line. Exams usually use a 360-day banker's year (12 months of 30 days) unless told to use 365 days (actual/exact method).
Two categories matter:
- Prepaid (paid in advance): the seller already paid for time the buyer will enjoy → credit the seller, debit the buyer. Example: HOA dues or insurance paid for the full period, or property taxes paid ahead.
- Accrued / in arrears (owed but not yet paid): the seller used the property but the bill is not due yet → credit the buyer, debit the seller. Example: property taxes billed in arrears.
Decide direction first by asking: did the seller pay for time the buyer gets (prepaid → seller credit), or did the seller use time not yet billed (arrears → buyer credit)?
Worked proration — taxes in arrears (360-day year)
Annual property taxes are $3,600, billed in arrears (not yet paid). Closing is March 31. The seller owned Jan, Feb, and March = 3 months.
- Daily rate (360-day year): $3,600 ÷ 360 = $10/day
- Monthly rate: $10 x 30 = $300; seller's 3 months = $900
- Because taxes are in arrears (unpaid), the seller owes for time used: debit the seller $900, credit the buyer $900. The buyer will later pay the full bill, so the buyer is reimbursed for the seller's share.
Worked proration — prepaid rent
A seller of a rental collected $1,500 rent for all of June. Closing is June 15 (seller owned 15 days). Using a 30-day month:
- Daily rent = $1,500 ÷ 30 = $50/day
- Buyer's share (June 15–30 = 16 days, or 15 remaining depending on closing-day convention; using 15 days): 15 x $50 = $750
- Rent was prepaid to the seller for time the buyer will own → credit the buyer, debit the seller $750.
Settlement checklist
- Place the sales price (buyer debit / seller credit).
- Credit the buyer for earnest money and the new loan.
- Debit the seller for loan payoff and commission.
- Prorate taxes, interest, insurance, HOA, and rent by who used the period.
- Net the columns: buyer's cash to close and seller's proceeds.
Mortgage interest proration trap
Mortgage interest is paid in arrears, so the payment due on the first of a month covers interest already used the prior month. On a payoff, the seller owes per-diem interest from the last paid date through the closing date. If a $200,000 loan carries 6% interest, annual interest is $12,000, so the daily rate (360-day year) is $12,000 ÷ 360 = $33.33/day. A seller closing 12 days into a new interest period owes 12 x $33.33 = $399.96 as a seller debit on the payoff. Buyers prepay interim interest on the new loan from closing to month-end as a buyer debit at closing.
Who pays what — customary allocations
Many closing costs are negotiable, but exams expect customary defaults: the seller typically pays the brokerage commission and owner's title policy in many areas; the buyer typically pays loan-related fees (origination, appraisal, credit report, lender's title policy) and recording of the deed and mortgage. Transfer taxes vary by locale. The critical exam habit is to read who the fact pattern says agreed to pay, because contract terms override custom. When the problem is silent, fall back to the customary side, then place the item as a single-entry debit to that party.
Annual taxes of $2,400 are billed in arrears and unpaid at closing. Closing is at the end of April (seller owned Jan–Apr = 4 months) using a 360-day year. How does the proration appear?
On the buyer's side of the closing statement, which of the following is a CREDIT?