Shopping for a mortgage can be confusing because of all the unfamiliar words used by your mortgage lender. In fact, one question that may arise early on is, what is PITI?
PITI is actually an acronym. It stands for principal, interest, taxes, and insurance. It's necessary to calculate PITI for every potential mortgage loan as this calculation can determine whether or not you'll be approved for the financing you need.
You not only need to be able to answer the question, what is PITI, but you also need to know how to calculate yours.
PITI accounts for the key components of your mortgage payment. They include principal, interest, taxes, and insurance. You can use our mortgage calculator to get a feel for some of these costs.
The first big monthly cost you'll incur as a homeowner is your mortgage loan repayment. You're charged a certain amount each month throughout the mortgage term towards your loan principal and interest.
If you borrowed at a fixed rate, this should remain the same throughout the loan term. If you have an adjustable rate mortgage, your monthly payment could fluctuate. It's calculated based on interest accrued plus the portion of your principal balance you'd have to pay to get the balance to $0 by the end of the term.
The “P” and “I” in PITI stand for Principal and Interest. So that's the first part of the answer to the question, what is PITI.
Your monthly mortgage payment isn't the only cost you incur. You also have to pay real estate or property taxes. The amount of tax you owe is based on the tax rate where you live and the appraised value of your property. It must be considered when determining what is PITI.
Some lenders require you to add your tax payment to your monthly mortgage payment. If so, your lender puts the money into what's called a mortgage escrow account and uses it to pay your taxes when they're due. If you waive mortgage escrow, you won't have to pay a portion of the tax bill to your lender each month. But you still need to factor real estate taxes into your housing costs.
Taxes are the “T” in PITI and estimating your tax bill is a key part of figuring out what is PITI.
Finally, lenders require you to buy homeowners insurance to protect your home because your property is the collateral that secures the loan.
Insurance payments may need to be paid into escrow on a monthly basis, in which case the lender would pay the insurer when the bill is due. Be aware that homeowners insurance may not cover all circumstances, for example if there is a high risk of flooding, you may need additional flood insurance.
If you've waived escrow, you'd be responsible for paying the insurance cost yourself but the monthly amount due is still factored in. If the down payment on your home is less than 20%, you're also required to pay private mortgage insurance (PMI). PMI protects the lender in case you default.
The insurance payments are the other “I” in PITI and are the final part of your answer to the question of what is PITI.
Finally, if you're required to pay homeowner's association fees, lenders may factor those into PITI as well. That means you'll need to know if you're buying in an HOA neighborhood when calculating what is your PITI.
Looking beyond the question, what is PITI, you also need to know why it's so important.
PITI matters because lenders use this number to determine how much you're allowed to borrow. Mortgage lenders don't just loan a borrower an unlimited amount of money. They want to make sure you're able to afford to pay back your loan -- and they'll consider your debt-to-income ratio to determine that.
Your debt-to-income ratio, or DTI, is the amount of debt you have relative to income. There's both a front-end ratio and a back-end ratio and both use PITI in the calculations. To determine these ratios, you'll need to be able to answer what is PITI.
The front-end ratio simply compares PITI to your gross monthly income, without taking any of your other debts into account.
Let's say your monthly payment towards principal and interest on the mortgage, plus your taxes and insurance, adds up to $1,200 per month. This is the number used to determine your ratio. If your monthly gross income is $5,000 per month, divide $1,200 by $5,000 to get a front-end debt-to-income ratio of 24%.
Lenders typically want to see a front-end debt-to-income ratio of around 28% at most. If yours is higher, you may not be approved for a home loan or your interest rate might be higher because you present a bigger risk. Some of the best mortgage lenders for first-time homebuyers may be more forgiving, though, so be sure to shop around.
The back-end ratio takes your PITI payment into account along with your other monthly debt obligations. If you owe on a loan, a car payment, and a credit card payment, those are factored in.
If your PITI was $1,200 and your other monthly expenses added up to $600 per month, your back-end ratio would equal $1,800 divided by $5,000 or 36%. Typically banks prefer your back-end ratio to be 36% or lower, although some lenders allow you to go as high as 43%.
If your debt-to-income ratios are low, you are more likely to qualify for a good mortgage rate -- especially if you have a good credit score. If your DTI is too high, you may need to buy a less expensive house so you can borrow less and lower your PITI. Or, you could pay down other debt to get a better back-end ratio and increase your chances of loan approval.
Since you'll need to come up with a plan, it's helpful to answer the question, what is PITI, and calculate yours early in the process.
In some cases, mortgage lenders require you to have certain cash reserves before you can be approved for a loan. Mortgage lenders put reserve requirements in place to ensure you're able to keep paying your mortgage bills even if you lose your income for a while.
The reserve requirement varies by lender, but two months of PITI is common. So, if your PITI was $1,200, the lender would require you to show you have $2,400 in a savings account before they'd approve your loan.
The possibility you'll have to put money in a deposit account is another good reason to make sure you've answered the question, what is PITI, early on.
There's no sense in falling in love with a home you can't afford. To avoid this, you can calculate PITI for any home you're considering now that you've answered the question what is PITI.
You just need to know the taxes, estimated insurance costs, and what your likely mortgage payment would be. Once you know this number, you can determine if you're likely to be approved for a loan from the best mortgage lenders based on your debt-to-income ratio. And you can determine whether your housing payment will be affordable.
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