What is PITI?
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PITI (Principal, Interest, Taxes, and Insurance) comprises the total payment to be paid on a mortgage after adding up the principal amount, interest on the loan, property tax, and related property or private insurance premiums.
The simplified value holds great significance for lenders as it helps in decision making and filters out non-worthy borrowers. It is also very important to borrowers as it helps them decide if they can afford to buy a certain home or not.
How is PITI Calculated?
To calculate the PITI amount for use, one needs to first calculate the values for principal, interest, tax and insurance premiums on a monthly basis.
Principal: This is the portion of the loan payment that is directly attributed to reducing the total balance. Interest payments do not reduce the principal amount. All principal payments made over the life of a loan will add up to the original loan amount.
Interest: A lender earns most of its profit on a loan by charging interest. The loan amount is amortized over a predetermined period of time, and the longer the repayment period is, the more interest will be paid during the life of the loan. With a fully amortized loan, the portion of each payment allocated toward interest will decrease in value over time as the principal balance decreases. This happens even when the interest rate is fixed.
Taxes: The amount of property tax to be paid on the property depends on the rates being applied as per the governing authority for the property. It is usually reassessed upon the sale of a property and needs to be clarified with the operating tax authorities. Once the annual property tax amount has been determined, many borrowers and lenders will set up an escrow account, which collects an additional portion of each monthly payment to cover these property taxes. The escrow funds are then saved and used to pay the annual or bi-annual property tax bill each year.
Insurance: When the property owner pays for the cost of hazard insurance (and in the case of a rental property, liability insurance can be included as well), they can do in a similar fashion by adding this additional portion to their monthly payment, which can go into their escrow account.
When the cost for each of these items is calculated, the sum is what is commonly referred to as PITI (Principal, Interest, Taxes, and Insurance).
Want to run your own PITI calculation? You can do it with our calculator below!
Why is PITI Important?
The monthly quoted value of PITI plays an important role in getting a real estate loan approved from a lender’s perspective. The sum of all four elements provides an easy ‘bottom line’ benchmark for lenders to identify and approve those individuals who are able to pay off the mortgage with a low possibility of default.
Lenders prefer to use PITI values with two front-end ratios and back-end ratios to identify creditworthy and less risky borrowers for the loan.
The front-end approach is to compare PITI to total monthly income. Generally, a lender would prefer that PITI is either equal to or lower than 25% of the borrower’s gross monthly income. This is because it can be assumed safely that 25% of one’s income can easily be used to pay debts while having enough money to spend on other expenses like food, clothing, etc.
On the back-end ratio decision, the value of PITI and other liabilities maturing are compared to monthly gross income as a whole to figure out how easily a borrower is able to cater to all debt obligations such as car loan payment, student loans, etc. in addition to the mortgage. The benchmark is usually set at 36% or lower to make sure there is sufficient affordability on the individual’s end.
Furthermore, some lenders set a reserve requirement in multiples of PITI to cushion against non-payment or default on loan. The borrower is required to have a reserve set aside to be used in repayment if they face any income loss. This acts as a back-up pool of funds to protect the lender. If the reserve requirement is set as a multiple of 2 and PITI value is $1,000. The total amount to be maintained in the reserve would be $2,000.