Let’s not make things too complicated about prorations in real estate. In real estate, there are situations where we need to divide the operating expenses of a property. These divisions will usually happen because of some transfer. Think about it as a moment that you will transfer ownership or possession.
An example will be helpful.
If you own a property for one-half year and then sell, you will owe one-half year of the property taxes. When property taxes get collected at the end of the year, the new buyer will have to pay the taxes at the end of the year. This part includes the part of the year when you were still the owner.
The solution that gets applied is to calculate the property taxes are yours. The part the new owners owe gets paid when owed. You will give the buyer your part of the property taxes to the buyer at the sale so they can pay later. This process is an example of what prorations in real estate are. Four situations that use prorations are; property taxes, homeowner association fees, mortgage interest, and insurance policy rent prorations.
Real estate Prorations
What Is Pro Rata?
Pro rata is a Latin term used to describe a proportionate allocation. It translates to “in proportion,” a process where the money gets distributed in equal portions.
Real estate property tax calculations
Some important things to consider when prorating real estate fees:
- which party will pay for the “day of” the sale
- what is the daily rate of the amount (total amount / 365 = daily rate)
- The proportion of time that each party will have possession of the property
Prorated Mortgage Interest
Prorations are also used with mortgages. Prorations are needed when you sell or refinance. We must find how much interest has accrued in a month, up until the closing date. This amount is owed to the mortgage company.
As of the closing date of the new loan, interest is owed to the new mortgage company. Before the closing date, interest is owed to the previous mortgage company.
Mortgage interest is paid in arrears, unlike rent. In a rental situation, you “pay, and then stay.” With mortgage payments, you “stay, and then you pay.”
Interestingly, mortgage companies want to collect up to 30 days of interest before the first mortgage payment is due. If you close on November 15, your first payment will be due on January 1. Interest from November 15-30.
Some insurance policies are transferred to the new owner. Flood insurances are one example. The property seller is reimbursed for the part of the policy they have paid BUT will not own the property for a portion of the policy period. The unused portion of time is what they will be reimbursed.
Essential terms for insurance policy transfers are “with consideration” and “without consideration.” “With Consideration” will reimburse the owner for the unused portion of the policy. “Without Consideration” means the owner does not get reimbursed for the unused part of the policy.
What if you buy a property in the middle of the month? The tenants typically pay rent on the first of the month (pay and then stay, remember?). If you buy the property in the middle of the month, the tenants stay in your property for a one-half month. Therefore, the previous owner should prorate the half month’s rent to you at the sale. FYI, they also need to transfer any deposits to you.
What is tax proration in real estate?
Tax proration in real estate is when you calculate the daily rate of the property taxes on a property. Then, multiply the days each party owns or occupies a property. This process assigns costs to the parties involved in a real estate transaction
How to calculate proration in real estate
You calculate the daily rate of the property taxes on a property and multiply the number of days each party owns or occupies a property.
What is Proration real estate? definition
The definition of proration in real estate is related to the Latin phrase “pro rata which is a term used to describe a proportionate allocation. It essentially translates to “in proportion.” The divided resource is distributed in equal portions
The basis for calculating prorations in real estate is to establish what portion of the expenses are owed by each party involved in a real estate transfer. Expenses may include; property taxes, insurance policies, HOA fees, rents, and more. The standard calculation is to take an amount owed or already paid and divide it by 365 days. The daily rate is thus. Then, multiply the daily rate by how many days the respective parties will own. Decide who will pay the expense on the day of closing. Then, the only thing left to do is appropriately collect the money from the correct party.