It's very common to see a purchase contract with provisions for prorations. This type of contract should be read closely and you should understand the prorations before signing. It may even be necessary to request a change to the verbiage used for the prorations.
Most of the time, the buyers are the ones responsible for the prorations. These changes will often show up as a debit on the closing statement for the buyer and will be a credit on the sellers closing statement.
Prorations usually increase the net profits of the seller and they cover items which were prepaid by the seller for a time when the seller won't own the property.
Prorations for Mortgage Interest
Sometimes, you will need to understand what the mortgage interest prorations are all about. Since mortgage payments actually cover the interest from the month before, the mortgage company wants to collect up to 30 days of interest before the first payment comes due.
Often, if you close on the loan in the middle of the month, you won't have a mortgage payment due for about 45 days. This mortgage payment will only cover the interest for the month before, which leaves 10-14 days of interest not paid. Mortgage companies may prorate this interest and collect it at closing.
Prorations for Real Property Tax
Another proration you may see is the real property tax proration. This proration covers any taxes in advance and sometimes some in arrears. This all depends on the time of year.
Other Prorations you may encounter include:
- Rent Prorations - If you purchase an investment property, you may see rent prorations show up on your contract.
- Homeowner Association Dues Proration - This is a very common proration and allows some of the monthly dues to be collected upfront.
- Insurance Prorations - Insurance is paid in advance and often this proration will show up during a new purchase.
- Utility Prorations - This proration isn't as common, but occasionally you will see it show up.
Make sure you understand any potential prorations before you sign the purchase contract. If you're unsure about a proration, ask your real estate agent and they can help explain it better to you.