Topic 14.3: Prorated Expenses

Learning Objective

After successfully completing this topic, you will be able to prorate the buyer’s and seller’s expenses.

Overview

Many expenses and income of the property do not “cut off” on the day of closing and must be apportioned (prorated) between the parties. Some examples include prepaid rent, ad valorem taxes, and mortgage insurance on assumed loans.
• Normally the prorations are based on a 365-day year, but an exam problem could ask for a 360-day proration. It’s done the same way, just use a different number of days.
• Normally, the day of closing belongs to the buyer, but stay alert for exam problems showing the seller has the day of closing.
• When getting the daily rate, round to five places and use that for prorating.
• Proration debit and credit entries are always equal.

Date of Prorations

Normally, prorations are made as of midnight of the day before closing. If the closing is on Thursday, you should prorate through Wednesday. This is commonly stated as “the day of closing belongs to the buyer.” If a test question says the day of closing belongs to the seller, add one day to the seller’s total days.

Annual items like taxes are normally prorated using the 365-day method. Divide the annual cost by 365 to get a daily rate, then multiply by the number of days.

If a question asks you to prorate using the 360-day method, the math is done the same: Divide the annual cost by 360 to get a daily rate, then multiply by the number of days.

Prepaid Rent

If the buyer is purchasing investment property and a tenant is in the property, the seller will have collected rent from the tenant. The buyer has a right to the portion of the rent that applies to the day of closing and afterward. The rent is divided by the number of days in the rental period and allocated daily.

To calculate the amount of prepaid rent the seller owes the buyer,
get the daily rate: monthly rent ÷ days in the month x number of days the buyer owns the property in the month of closing.

Note: Some rent proration problems will also show that the seller has collected a security deposit in the amount of the rent, as well as the last month’s rent. If that were the case in this problem, simply add $1,800 for the security deposit, and $1,800 for the last month’s rent. Proration would be $4,740 ($1,140 + $1,800 + $1,800).
Note: Some problems will show a duplex as the property, but will give the monthly rent for each unit. Don’t forget to multiply by 2.

Example of prepaid rent proration
Closing date is May 20
Monthly rent collected in advance by the seller is $1,800.00
Daily rate is $58.06452 ($1800.00 ÷ 31 days in May)
Proration is $1,103.23 ($58.06452 X 19 days)
The proration would be entered on Page 3 of the Closing Disclosure as a debit (charge) to the seller, and a credit to the buyer.  

Ad Valorem Taxes 

Every closing will have a property tax proration. Property taxes are paid annually, and are due in arrears, meaning the taxes will be paid at the end of the year. To prorate property taxes, divide the annual taxes by 365 days to get a daily rate, then multiply the daily rate times the number of days the seller has owned the property.

Note: In some cases, the seller may have already paid the taxes (if the closing occurs in November or December). In that case, figure the amount of days the buyer owns the property, multiply the days by the daily rate. Debit buyer credit seller.

Example of property tax proration
Closing date is May 20
Property taxes are $2,845
Daily rate is $7.79452 ($2,845.00 ÷ 365)
Number of days from January 1 through May 19 is 139 (see below)
January 31
February28
March31
April30
May19
Total139

Proration is $1,083.44 ($7.79452 X 139 days)
The proration would be entered on Page 3 of the Closing Disclosure as a debit (charge) to the seller, and a credit to the buyer.

Mortgage Interest on Assumed Mortgages

When a buyer assumes an existing mortgage when buying, the mortgage interest must be prorated between the parties. Interest on mortgages is paid in arrears, meaning that the buyer will have to pay the interest for the month of closing, and should get a proration from the seller for the portion of the month the seller owned the property.

Example of mortgage interest proration
Closing date is May 20
Mortgage balance is $148,345.60
Interest rate is 5%
The annual interest is $7,417.28 ($148,345.60 x .05)
The daily rate is $20.32132 ($7,417.28 ÷ 365)
Number of days from May 1 through May 19 is 19
Proration is $386.10 ($20.32132 X 19 days)
The proration would be entered on the Closing Disclosure as a debit (charge) to the seller, and a credit to the buyer.  

In most test questions concerning interest on assumed mortgages, the student will be given the mortgage balance and the interest rate. Some questions will also give the monthly mortgage payment, but that’s not used in the calculation.

Calculating the interest proration

The proration is made by first calculating the annual interest on the loan, dividing it by 365 days, and multiplying the daily rate by the number of days used by the seller in the month of closing.