What Are Prorations?
UPDATED: August 23, 2013
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Prorations can be many different things, from the distribution of materials to a smaller monthly payment due to the startup of a service. Prorations are usually thought of in terms of monetary payments, and are used extensively in relation to real estate.
There are a number of different situations where prorations come into play. Mortgage interest is paid in arrears. So, if you make a mortgage payment in February, you are paying the interest for January. When you have a new mortgage loan, lenders usually want a month of interest paid before you make you first mortgage payment. So if you close on a house or property in the middle of April, your first mortgage payment will be due the first of June. It will include the interest for May and any days after the close of the sale in April. If you closed on April 15th, you would pay half a month of interest plus the interest for May.
Another area where prorations come into use is in property tax. Property tax regulations differ from state to state, with some states collecting in arrears, some in advance, and some collections depending on the time of year. If you are selling real estate and the taxes have been prepaid, then you will receive a credit. If you are the buyer, then you will have to pay them. It the taxes are not due yet, the seller will get what is called a debit proration and the buyer will get a credit proration. However, purchase contracts sometimes have a “no proration” clause in them, which can change the way the taxes are paid. In some situations and locales, utility bills are also prorated at closing. All these details need to be included in the purchase contract. This comes up often in situations with short sales and foreclosures.
Homeowner Dues is another example where proration often occurs. The Homeowner Association usually collects dues upfront. If the deal closes on the 10th of a month, for example, the seller will pay the HOA dues for 10 days and the buyer will pay then for the rest of the month.