PITI (pronounced “pity”) is a widely used mortgage acronym. Here is a breakdown of the term and how it relates to your loan approval. Read on!
Mortgage companies have their fair share of acronyms and PITI is not only one of them, but perhaps the most widely used. It is a critical piece of the loan approval process, as lenders use it to determine affordability.
So, what is PITI?
PITI stands for principal, interest, taxes and insurance. Here is a breakdown of the term and how it relates to your loan approval:
When you make a monthly payment, there is a portion allotted to each of the four elements of PITI. One portion is applied to the outstanding balance of your loan. This is your principal balance. In the early stages of a mortgage loan, more of the payment goes toward interest and less goes toward principal. Over time, as the loan is paid down, more money goes to the principal balance and less goes to interest.
Lenders are in business to lend money at a profit. This profit is the interest paid by the borrower. With a fixed rate loan, the mortgage payment stays the same, but the portion of each payment allotted to interest and principal will vary each month. With an adjustable rate loan, the amount of interest can vary based upon the newly adjusted rate.
This is the amount you’re charged to cover your annual or semi-annual property tax bill. For those who escrow or impound their taxes, instead of paying property taxes directly to the local tax assessment office, the taxes are included with the monthly mortgage payment and the lender pays them when due.
This is the sum required to pay for your homeowners insurance policy when it’s time to renew. Each month you will pay 1/12th of the annual insurance premium to your lender, who will then pay the premium amount when the policy comes up for renewal. In certain areas, a property might be designated as being in a Flood Zone, in which case an additional policy will be required. In a condo, the only insurance you’ll pay for is a “walls in” policy which protects the property you own: the square footage inside your unit.
HOA stands for Homeowners’ Association, and is usually found in condominium housing as well as in Planned Unit Developments or PUDs. Each resident is charged a fee for enforcing the various covenants, conditions and restrictions of the building or community.
If you don’t live in a condo or a PUD you most likely won’t be a member of an HOA, but if you are, this amount is not optional. It is a requirement for living in your home. The collective funds are applied to the upkeep of common areas, as well as to other requirements.
PITI in Action
Let’s look at a scenario to illustrate how lenders use PITI in the approval process. A couple has found a home for sale at $300,000 and wants to borrow $200,000. Using a 30-year fixed rate of 4.00%, the principal and interest payment is $954.
Annual property taxes on the home they want to buy are $3,000 per year, or $250 per month. After shopping around for an insurance policy, they’ve found what they need at an annual premium of $1,500 per year, or $125 per month. The PITI in this example is $954+$250+$125=$1,329.
When lenders evaluate affordability, they compare the borrower’s monthly debt with his or her gross monthly income. In this example, the borrowers make $5,000 per month combined. If you divide the PITI of $1,329 by $5,000 the result is .27, or simply “27.” Most loan programs like to see this ratio of debt-to-income somewhere below 33.
Now, the lenders will add up other monthly credit obligations such as automobile or student loans. If there is an auto loan of $500 per month, and student loans adding up to $300 per month, the lender adds these amounts to the PITI of $1,329, arriving at $2,129. Dividing this amount by $5,000 gives a ratio of 43, which is acceptable for most loan programs.
Don’t fall into this trap!
When first time buyers begin their research, and they run some numbers on a mortgage calculator they find online, they may not be aware that lenders will use not just the principal and interest payment the calculator provides, but also the estimated monthly payments for taxes, insurance and any HOA dues. Online mortgage calculators typically don’t provide space to enter that information.
Most loan programs in today’s marketplace will require monthly payments for taxes and insurance if the mortgage is greater than 80 percent of the value of the property. For those who put down 20 percent, or who otherwise configure a loan where the first mortgage is at or below 80 percent of the value, making monthly payments for taxes and insurance is optional, it is not a requirement. Even in such cases, the lender will calculate the entire PITI amount when qualifying a borrower.