Principal, Interest, Taxes, Insurance - PITI
What is 'Principal, Interest, Taxes, Insurance - PITI'
Principal, Interest, Taxes, Insurance (PITI) refers to the components of a mortgage payment. Principal is the money used to pay down the balance of the loan; interest is the charge paid to the lender for the privilege of borrowing the money; taxes refer to the property taxes paid as a homeowner; and insurance refers to both property insurance and private mortgage insurance.
BREAKING DOWN 'Principal, Interest, Taxes, Insurance - PITI'
PITI is typically quoted on a monthly basis and compared to a borrower's monthly gross income for computing the individual's front-end and back-end ratios, which are used to approve mortgage loans. Generally, mortgage lenders prefer PITI to be equal to or less than 28% of a borrower's gross monthly income.
How PITI Influences Mortgage Underwriting
Because PITI represents the total monthly obligation a homeowner carries on his mortgage payment, it serves as a useful figure to plug into several formulas used to determine if a borrower can reasonably afford a given mortgage.
The front-end ratio compares PITI to gross monthly income. This is the ratio that most lenders prefer to equal 28% or less. If borrower's PITI equals $1,500 and gross monthly income equals $6,000, the front-end ratio, then, is 25%. This is an acceptable level to most lenders.
The back-end ratio compares the total of PITI and other monthly debt obligations to gross monthly income. Most lenders prefer to see a back-end ratio of 36% or less. If the above borrower making $6,000 per month has a $400 car payment and $100 minimum credit card payment in addition to PITI of $1,500, the borrower's back-end ratio is 33%.
Some lenders also use PITI to calculate reserve requirements. Lenders require reserves so that if a borrower temporarily suffers an income loss, money still exists to make the mortgage payment. Often, lenders quote reserve requirements as a multiple of PITI. Two months of PITI represents a typical reserve requirement. Therefore, the above borrower, if subjected to this requirement, would need $3,000 of seasoned funds in a depository account to be approved for a mortgage.
Not all mortgage payments include taxes and insurance. Some lenders do not require borrowers to escrow these payments as part of their monthly mortgage payment. In these scenarios, the homeowner pays insurance premiums directly to the insurance company and property taxes directly to the tax assessor. The homeowner's mortgage payment, then, consists of only principal and interest.
Most lenders, however, still consider the amounts of these payments, even if they are not escrowed, when calculating front-end and back-end ratios. Moreover, additional mortgage-related monthly obligations, such as homeowner's association (HOA) fees, may be lumped with PITI for the calculation of debt ratios.