If you haven’t gathered already, the lending business has come up with its own lending vocabulary. When you prepare to buy your first home you’ll hear terms you’ve never before heard. Mortgage lenders use this terminology each day, every day, with abandon. After all, it’s their business and their lingo. One of the most used terms is “PITI.”
What is PITI?
PITI stands for principal, interest, taxes and insurance, and is used to calculate your (another lender term) housing debt ratio, sometimes called a front end ratio. A housing debt ratio is a number arrived at by dividing PITI by the borrowers’ gross monthly income. Lenders have predetermined housing debt ratio guidelines they use when approving mortgage loans.
For example, if PITI is $4,000 and the borrower’s income is $10,000, then $4,000 divided by $10,000 = 40%. The housing debt ratio in this example would then simply be “40.”
Rent is one payment. Yet PITI is a collection of many. Let’s break these down and take a closer look.
Mortgage loans are amortized over a fixed period for, say, 30 or 15 years. When you hear the phrase “30-year fixed rate mortgage” it means not just that the rate is fixed, but that it will be paid off, or amortized, in 30 years.
Each monthly mortgage payment in these loans consists of two items; principal and interest. The principal portion goes directly to pay down the principal, or the initial loan. The remaining amount is interest; the amount that goes directly to the lender who issued the loan. Yet so far “PITI” is missing two more components, taxes and insurance.
Taxes, or more specifically property taxes, are typically paid once or twice per year and paid to various governmental agencies. Some homeowners pay their taxes on this schedule, yet for purposes of calculating home affordability; this annual tax bill is divided up into monthly installments.
Homeowners insurance, paid annually, is also divided by 12 to get a monthly amount to conclude the PITI definition. Note: most lenders require a form of homeowners insurance often referred to as HO6 for condo type properties.
But, there can be more.
Most mortgage loans where the loan amount exceeds 80% of the value of the home may also include private mortgage insurance, or PMI. Still other government-backed loans such as FHA carry their own version of PMI, called MIP, which stands for mortgage insurance premium in the case of FHA. With FHA loans you pay this MIP regardless of the amount you put down, and you pay it for the life of the loan.
PMI is a separate insurance policy paid by the borrower, which protects the lender in the event the loan goes to foreclosure. The “insurance policy” pays the lender for approximately the difference between 20% down and the actual down payment. For instance, if a home sells for $500,000, then 20% down would be $100,000.
If the borrower only put down $50,000 and borrows $450,000, there might be a PMI policy in favor of the lender for the difference between $100,000 and $50,000. PMI is not always a requirement, yet when it is, this monthly payment must be included in the PITI number.
If the property is a condo or is a member of a homeowners association which has annual or monthly dues, then this amount must also be included.
Still, other times a second mortgage is used to help purchase a house and has its own principal and interest calculation as well. This too is included in the total PITI payment.
So how does all this look when put together?
If we had a 30 year fixed rate mortgage on a $400,000 note at 3.75%, the principal and interest payment would be $1,852. If property taxes were $4,000 per year the monthly tax amount would be $333. Now add an annual homeowners insurance premium of $2,000 and the monthly insurance would come to $167.
So far we have:
P&I = $1,852
Taxes = 333
Ins. = 167
Now let’s say there’s a $100 per month homeowners association due. The payment would read:
P&I = $1,852
Taxes = 333
Ins. = 167
HOA = 100
For those that have always paid rent each month the breakdown of PITI is surprising. Yet to a lender it’s one of the most important numbers used when approving your home loan. So get to know your new friend: PITI!