How are prorations calculated at closing, and what is the difference between 365-day and 360-day calculation methods?
Prorations allocate annual expenses between buyer and seller based on the number of days each party owns the property. Daily rate = Annual Amount divided by 365 (or 360). Multiply the daily rate by the number of days to get the total proration. The buyer is typically debited (charged) for their period; the seller is credited (refunded) for their period.
Key Takeaways
- Prorations allocate annual expenses between buyer and seller based on the number of days each party owns the property.
- Daily rate = Annual Amount divided by 365 (or 360).
- Multiply the daily rate by the number of days to get the total proration.
- The buyer is typically debited (charged) for their period; the seller is credited (refunded) for their period.
Real Estate Math on the Real Estate Exam
Proration calculations are heavily tested math problems on all state exams. They require precise calculation and understanding of which party is debited versus credited. This is practical knowledge agents use at every closing to explain closing costs accurately.
Understanding Real Estate Math: Key Concepts
What It Means
Prorations divide annual expenses fairly between buyer and seller at closing. The closing date determines the division point. The seller is responsible for the property up to (but not including) the closing date. The buyer is responsible from the closing date forward. Common items prorated include property taxes, homeowner association dues, property insurance (if prepaid), rental income (in rental properties), and utilities.
The two main calculation methods are the 365-day method and the 360-day method. The 365-day method (also called the actual/actual method) uses the actual number of days in the year. For a $3,650 annual expense, the daily rate is $3,650 divided by 365 = $10.00 per day. If closing occurs on June 15, the seller is responsible for January 1 through June 14 (165 days), and the buyer is responsible for June 15 through December 31 (200 days, accounting for leap years if applicable). The seller receives a credit of $1,650 (165 days × $10); the buyer is charged $2,000 (200 days × $10).
The 360-day method (also called the 30/360 method) assumes 12 months of 30 days each, totaling 360 days. For the same $3,650 annual expense, the daily rate is $3,650 divided by 360 = $10.139 per day. This method is less common but may be required by contract or local custom. The resulting daily rate is slightly higher than the 365-day method, and the total proration will differ slightly. Both methods are acceptable; the contract should specify which applies.
Prorations appear on the settlement statement (HUD-1 or Closing Disclosure) as debits and credits to buyer and seller. Debits to the buyer mean the buyer pays that amount at closing. Credits to the buyer mean the buyer receives that amount (or the amount is deducted from what the buyer owes). Similarly, debits to the seller reduce the seller's net proceeds, while credits to the seller increase the seller's proceeds. Both parties receive a closing disclosure showing all charges and credits so they can verify accuracy. Common proration errors include using the wrong number of days, using the wrong daily rate, or crediting the wrong party.