Principal, Interest, Taxes, Insurance (PITI). MarketCheese

PITI is an acronym for principal, interest, taxes, and insurance, which are the main components of a mortgage payment. The mortgage is a specific type of loan used for buying a real estate.

There are different types of mortgage. Some offer a fixed amount of payment each month, some give an opportunity to vary these payments. The whole amount of mortgage payment varies too. It depends on several criteria, including the chosen type of mortgage.

Usually, PITI is equal to 28% of the borrower’s gross income per month or even takes less of it. This amount of payments per month mortgage lenders consider to be sufficient enough for them and affordable enough for the borrowers.

Definition of Principal, Interest, Taxes, Insurance (PITI)

Principal	The initial sum of the loan
Interest	The payment for borrowing money
Taxes	The contribution payment to the government
Insurance	The arrangement that protects the sides from financial loss

Principal is the initial sum of the loan that you borrow from a bank or another lender. For example, if you loan $75,000, the principal will be $75,000. This sum doesn’t include interest payments, taxes, and insurance fees. The final amount of money that you need to pay back will be bigger than the loan itself.

Interest is the payment that the lender requires for giving the loan and taking associated risks. The interest rate depends on different criteria such as the type of loan, its length, down payment, borrower's income, etc. Interest is calculated from the sum of borrowed money, or the principal. Usually, the first half of the mortgage payments mostly consists of the interest payments. This way the lender protects itself from the risk of losing profit. Then mortgage payments reach a tipping point, at which the borrower starts to pay more principal than interest.

Property taxes are regular payments on the owned real estate to the government. These payments vary in different countries, regions, or states. They are used to finance public services. You can pay taxes by the end of each year or pay them in parts each month. The lender can include taxes in your monthly mortgage payments and hold them in escrow till the moment they need to be paid.

Insurance is the final component of the mortgage payment. It’s an agreement between both sides of a contract to protect their capital. Basically, it’s a kind of a risk coverage for the lender and borrower. There are different types of insurance:

Homeowners insurance, which protects the borrower and compensates him for the money loss in case of unforeseen emergencies such as fire, flood, burglary, or other disasters.
Private mortgage insurance (PMI), in turn, protects the lender. It is an obligatory payment for the borrowers with the down payment under 20% of the property price.

Some lenders don’t take the responsibility for paying the borrower’s taxes and insurance. In this case the borrower has to make these payments individually through the relevant organizations.

Let’s consider all the aforementioned components of PITI in the following example:

You decide to buy a house for $350,000 and need to get a mortgage loan of $270,000 in order to do this. Imagine that you choose the conventional mortgage loan for 20 years with the interest rate of 6%. The conventional mortgage is the type of loan that isn't secured by the government. The property tax for the house is $2,000 per year. Home insurance is $1,000 per year. You pay the down payment of $80,000, which is more than 20% of the house price. So, you aren’t required to pay PMI. Considering all of these payments, your monthly mortgage payment or PITI will be about $2,184.36.

Nowadays there are a lot of accessible mortgage calculators which can help you to compute possible loan costs and compare different variants in order to find the most convenient option for you. The analysis of PITI also helps to determine the borrower’s capacity to pay off the loan and the affordability of the chosen property.

Criteria for a mortgage approval

There are a few criteria that influence the approval of the mortgage. The lender studies the borrower’s credit rating and credit history and also computes PITI in order to estimate the borrower’s creditworthiness.

PITI can be used for calculating the front-end and back-end ratios of the borrower:

The front-end ratio, otherwise known as the mortgage-to-income ratio, shows how much money the borrower would spend on the mortgage every month in comparison to his income per month. In order to compute this ratio you have to divide the approximate amount of the mortgage payment by the gross income for the month.
The back-end ratio, otherwise known as the debt-to-income ratio (DTI), compares the gross monthly income of the borrower to the total sum of his debts, including not only the mortgage payment, but other loans as well. The formula is quite the same, but you should divide the total amount of debt payments by the income per month. Besides debts, the back-end ratio can include some payments like homeowner’s association fees – the amount of money that owners of the specified property should pay to these associations each month. Also, the back-end ratio preferably should be 36% or less.

Overall, these metrics are designed to help the lender to estimate the borrower’s creditworthiness, or ability to repay the loan.

Suppose that the borrower would like to buy a house for $300,000. In order to approve or deny this loan, the lender has to check the borrower’s income and consider his debt burden. The client is ready to give $75,000 as a down payment. His monthly income is $15,000. So, the approximate amount of mortgage payment would be around $4,200 or 28% of his income. However, the borrower has a debt on the credit card which he must repay $2,500 per month. Considering this information we can count that the borrower’s front-end ratio is 28% and the back-end ratio is around 45%. The lender will probably deny the loan until the borrower pays back another debt.

Additional information

Also, PITI can be used for calculating reserve requirements, which some lenders demand as a supplementary precautionary measure. These requirements obligate the borrower to leave a certain amount of money in a deposit account in case of occasional losses or extra expenses from the borrower’s side. Usually, two months of the PITI payments are enough for this reservation. For example, if each month you pay $1,500 as a regular mortgage payment, your reservations will be around $3,000.