Debits vs Credits

Let's talk about Debits and Credits.

The real estate closing statement is a vital part of the home buying process. Every licensee should understand the basics, which is why you will see it on your real estate exam. Let’s begin with some basic definitions.

A debit is money you owe, and a credit is money coming to you. The debit section highlights items that are part of the total dollar amount owed at closing. This includes the amount due for closing and title costs, which are generally split between the buyer and the seller- who pays how much is generally negotiable.

The good news for the buyer is that there are often credits on the closing statement that reduce the amount of the check they need to write for closing. For example, if a buyer has put down a good faith deposit to hold the house, they will be credited for this.

The seller’s debit section includes the cost of all the items they are responsible for covering. This includes things like past due taxes, second mortgages on the home, and repairs or upgrades that need to be made before the buyer will purchase the home.

 Charges that show up on a closing statement as debits for the buyer and credits for the seller will    increase the seller’s net profits, as well as reimburse them for prepaid items and services that will now be the buyer’s responsibility.

On a closing statement, a debit for one side is usually balanced by a credit on the other side. For example, if a seller is credited for prepaid taxes they have already paid, there will be a debit for the buyer in the same amount.

The closing process may seem complicated, but it often boils down to signing a series of papers that protect the seller, buyer, real estate licensees, and financial institution that provides the loan. Here are some other items that can appear on a typical closing statement.

First let’s talk about loans.

If a buyer is moving in halfway through the loan period- mid-month, for instance- the buyer’s mortgage interest and other fees will be prorated to cover the period of time they’ll be in possession of the house. Unlike rent, which is paid in advance, mortgage interest is paid in arrears. For example, when you pay a mortgage payment on January 1, it pays the interest for December.

Taxes

Every state bases its property tax calendar year differently.  Some states collect property taxes in advance, some collect in arrears, and some collections depend on the time of year.

If taxes are prepaid and you’re the seller, you’ll receive a credit. If taxes are prepaid and you’re the buyer, you’ll receive a debit. The opposite is true if taxes are not yet due and payable-sellers receive a debit proration and buyers receive a credit proration.

Insurance Prorations

At the time of closing, sellers may find that they'll get money back for prepaid insurance. If the seller has paid insurance on your home through the end of June, for example, and closing is taking place in mid-May, the seller will get a refund for the amount of time remaining. They get a credit on the closing statement while the buyer gets a debit. 

Buyers typically take out a new hazard/fire insurance policy when buying a home. However, if the buyer is assuming the seller's existing loan or buying on a land contract, a buyer might ask the seller to transfer the existing insurance policy. In that case, the seller would get a credit and the buyer gets a debit.

Homeowner Association Dues Prorations

Since most homeowner associations collect dues upfront, if a seller has not yet paid the dues, they will be paid from the seller's proceeds. The seller will receive a credit for the unused portion of dues, and the buyer receives a debit.

Rent Prorations

Rent is generally paid in advance. Buyers who purchase an investment property can expect to receive a credit for that portion of the rent which covers the time period the buyer will own the property. For example, a sale that closes on November 15 and involves a tenant-occupied property which rents for $1,000 a month would result in the buyer receiving credit for 15 days of prepaid rent, or $500, while the seller receives a debit of $500. Security deposits held by the seller are also transferred to the buyer as a credit to the buyer and a debit to the seller.  

I hope that helps you understand debits and credits a little bit more!