Debits and Credits in Real Estate
Debit and credits in real estate come up during closing in a real estate transaction. A debit is money you owe, while a credit is money owed to you. Debits and credits are described on a closing statement in their sections respectfully.
In this article, we are going to define debits and credits, talk about how it deals with real estate, and of course, cover what you need to know about debits and credits for the real estate exam.
What are Debits and Credits?
Definition: Debit is money you owe, while credit is money owed to you.
Debit and credits in real estate come up during closing in a real estate transaction. It’s worth mentioning that because debits and credits in the accounting world are slightly different. In our case, debits and credits come up in closing.
Closing is the final step in executing a real estate transaction. It is when official ownership and payment is transferred to the appropriate parties. Closing usually occurs after a purchase agreement is made, and the title is now ready to be transferred.
On most purchase agreements, there will be a debit and credit section. The debit section highlights items that you owe at closing. At the same time, the credit section covers items that are owed to you. Generally speaking, these debits and credits go hand and hand, meaning a debit is usually balanced by a credit. They typically coexist with one another.
For example, if a seller is credited for repairs made on the house, there will be a debit for the buyer in the same amount. There are some exceptions to this rule, like if a seller’s debit is to a bank or the government, but generally speaking, they are between the buyer and the seller.
Debits and Credit Real Estate Examples
The most common debit and credit real estate example is when a buyer puts down an earnest deposit. An earnest deposit or earnest money is a deposit made to a seller representing a buyer’s good faith to buy a home. At closing, buyers will be credited for this in the form of a credit.
Here are some other debit and credit real estate examples. It’s worth mentioning who pays for what, and for how much, is almost always negotiable, but these are some general debit and credit real estate examples.
- Prepaid Property Taxes: If a seller has paid for the full years’ worth of property taxes and is selling the property, the buyer will then owe the seller the remaining months of taxes (see proration covered in real estate math). This means the seller would be credited for the taxes while the buyer would be debited.
- Prepaid Insurance: If the seller has paid insurance on their home and their policy still has time on it, the seller will get a refund for the amount of time remaining. The seller would be credited while the buyer would be debited.
- Prepaid Homeowner Association Fees: If the seller has prepaid HOA fees, the seller will get a refund for the amount of time remaining. The seller would be credited while the buyer would be debited.
- Past Due Taxes: If the seller has any past-due taxes, this could result in a seller being debited at closing.
- Repairs or Upgrades: If there are any repairs or upgrades that need to be made before closing, the buyer or seller can pay for them and, in return, receive a credit at closing.
Remember, every state is different. Generally speaking, it’s best to determine your state’s laws regarding debits, credits, and property taxes; some states differ slightly.
What to Know for the Real Estate Exam
What’s important to understand for the real estate exam is how debits and credits function. You might not be asked exactly what a debit or credit is, but you will be asked questions directly related to debits and credits. You’ll have to use your knowledge of those aspects to figure out property taxes, proration, closing problems, and more.