What is PITI?
If you’ve ever taken out a loan, chances are you’ve heard loan officers or lenders talk about PITI (pronounced “pity”) and wondered, what could they mean? It’s actually a pretty simple concept, and we’ll go over what it means and how it affects you as a borrower in this article.
There is a calculation that takes your loan amount or money borrowed and/or interest rates along with the term of your loan which calculates your principal and interest payment or PI. As described above most of the loans have an escrow account which is your taxes and homeowners insurance. When you take your escrow account add it to your monthly principal and interest payment you are left with your PITI or total monthly mortgage payment
What Does PITI Stand For?
When you take out a VA loan from a bank or mortgage lender, you’ll be charged interest on the loan over its life. But what you pay each month for your mortgage plus your interest is just half of your monthly mortgage payment. Your monthly payment is also made up of property taxes and homeowners insurance, which many borrowers funnel into an escrow account. All together, these four elements make up your total monthly mortgage payment. PITI, then, is an acronym for principal, interest, taxes, and insurance. Add up all these expenses, and you have your monthly PITI. Let’s look at each of these individual elements a little more closely:
The P in PITI stands for principle, which is the total balance of your mortgage excluding interest. It usually equals the sales price of the home, minus your down payment. For instance, if you purchased a $300,000 home and made a down payment of $20,000, then your principal would be $280,000.
A chunk of your monthly mortgage payment will always go towards your principle loan amount. As you funnel money into the principle and reduce it, you simultaneously increase the equity on your home. Equity is the portion of the house which you’ve bought and paid for through mortgage payments. While you technically own your house after closing on a loan, you still owe the lender money. But as soon as you start chipping away at your principle, you begin to own a percentage of the house, and thus, you create equity.
There are, however, interest-only loans, in which the borrower immediately starts paying off interest before they start paying off any principle. We’ll talk about these loans more in a moment.
One mortgage term that might be useful to know is “amortization.” If you’re making a mortgage payment that directs money towards both your principal and your interest, then you are making amortized payments. With this type of loan, you could potentially pay off your principal amount early. Some lenders may penalize you for doing this, but VA loan lenders and the majority of conventional loan lenders will not dole out pre-payment penalties.
What constitutes as paying off your mortgage “early”? There are two ways this could happen. First, let’s assume you have a thirty-year fixed-rate mortgage, and five years into this mortgage, you decide to sell your house or refinance your loan. If you switch lenders to do this, your new lender can pay your old lender the remaining principal of the loan you never finished. So, in a way, you are pre-paying your principal, because it didn’t take the full thirty years. The second instance is one in which you pay extra each month on your mortgage. Naturally, this will cause you to chip away at your principal faster and pay it off sooner than you might by making the minimum payments. Think about it this way: if you make just one extra payment per year, every year, you could knock approximately eight years off the life of your loan.
Now that we’ve established what P stands for, let’s move to the first I. This I stands for interest. Interest is a percentage of your outstanding principle; it’s basically how the lender profits from your loan. It’s what they charge you for borrowing their money. Here’s an example: let’s say you’ve taken out a loan of $200,000 dollars. Now let’s say you’ve been approved for an interest rate of 5 percent. That means you’ll be paying approximately $1,070 a month as your mortgage payment, with about $830 of that going towards interest and about $240 going towards principal at the beginning
As we mentioned before, there are interest-only loans in which all your payments go only towards interest. Then after a certain period of time, you start to repay your principal as well.
Initially, most of your mortgage payment will go towards interest. A 30-year fixed-rate loan is amortized in such a way that this is the case. However, as time passes, the more interest you’ll pay off, and so more money can start going towards your principal amount. Mathematically, the sooner you pay off your mortgage, the less interest you’ll end up paying to your lender. For instance, if you make extra payments every year at the beginning of your loan, you could save tens of thousands of dollars on interest overall.
The interest rate you get is based primarily on your credit and financial histories. You can qualify for a low interest rate by making a large down payment, having a clean and punctual payment history, never missing payments, and having a sufficient number of lines of credit to show you are capable of managing debt well. Loans for shorter periods of time than thirty years may also come with lower interest rates, because they will likely be paid off sooner.
The T in PITI stands for taxes, which in this case, are your property taxes. Property tax amounts are going to vary from state to state, county to county, so speak with your county assessor’s office to obtain the exact numbers. Sometimes, your property tax goes towards several things, such as education, construction, street maintenance and lighting.
Since property tax payments are usually big and infrequent, many borrowers choose to set up an Escrow account with their lender, through which their property tax can be paid. Here’s how it works: you’ll pay a little extra on your mortgage payment every month, and your lender will put that extra amount in your escrow. Then at the end of the year, your lender will use the money in your escrow account to pay your property taxes for you, so you don’t have to worry about forgetting or not having enough money. Escrow accounts are also used by lots of borrowers to pay private mortgage insurance. VA loans, however, don’t come with private mortgage insurance. Instead, that expense is replaced by the VA funding fee.
We’ve now come to the last I in PITI, which stands for insurance. Homeowners insurance requirements vary by state, but regardless of where you live, it is highly recommended that you invest in insurance. If you live in an area with a high flood risk, your lender will most likely require you to invest in flood insurance; the same goes for earthquake or fire insurance.
Besides these, there are broader insurance plans such as HO1, HO2, or HO3, all of which are policies that cover varying amounts of disasters, such as lightning, rioting, erosion, etc. Some insurance plans are “bare-bones” plans, covering only the external structure of your home while other plans can insure individual objects like jewelry or paintings. You’ll want to do your research long before closing, insofar as which kind of homeowners insurance you want or need. Again, we strongly encourage you to invest in some form of insurance; a bare-bones policy is better than nothing in the event of a disaster.
Conventional loan lenders will charge their borrowers private mortgage insurance if they make a down payment smaller than 20 percent of the principal. However, as we said before, VA loan lenders do not charge borrowers for private mortgage insurance.
Like your property taxes, insurance payments can be made by your lender via your escrow account. Additionally, your insurance premiums can sometimes affect your interest rate. Just as we encourage our borrowers to refinance their loan when a better interest rate comes along, it may also be wise to shop around for different insurance providers to find a good premium.
What Does PITI Mean for the Borrower?
So, now that you know what PITI is, you may be wondering, what does PITI mean for me? Well, your calculated PITI is going to affect your loan application; lenders, and specifically underwriters, are going to consider it when deciding whether or not to approve you for a loan. They’ll compare your estimated PITI against your gross monthly income as a way of determining your capacity to make your monthly payments and repay the loan in general. Though there isn’t a set number or rule, most lenders prefer your monthly PITI to equal no more than 28 percent of your income. For example, if your monthly PITI is $1,500 and your gross monthly income is around $6,000, then approximately 25 percent of your monthly income going towards your PITI. This is below 28 percent, so the lender would consider it an acceptable percentage.
Now, if you have a car, cell phone, or if you’ve ever been to college, you have other forms of debt besides your mortgage. When considering these debts in addition to your PITI, lenders prefer they cost a percentage of your income no higher than 36. For example: let’s say you make $6,000 a month, and in addition to your PITI of $1,500, you have a $400 car payment and a $100 credit card payment. In this instance, your total debt-to-income ratio will be around 33 percent. And that’s less than 36, so you’re good!
Sometimes, lenders and underwriters will consider a multiple of your PITI as the minimum number of reserve assets required for approval. For example, if you had a PITI of $2,000, then the lender might require you have at least $4,000 in reserve assets just to make sure you can still make your PITI payments every month even if you lose your job or are cut off from your primary means of income for a time. As always, the less of a risk you are as a borrower, the more comfortable a lender will be giving you a loan, and the lower your interest rate can be.
Another way your PITI can influence your loan application is when it comes to your debt-to-income ratio, or DTI. This is a ratio which illustrates how much of your monthly income goes towards debts, such as your mortgage, phone, or car payments. PITI is a useful tool insofar as computing risk; it represents all your obligations concerning a mortgage payment, so lenders often use it to evaluate your loan application in a myriad of ways.
How to Calculate Your PITI
To calculate your PITI yourself, you can use this online PITI calculator. It’ll require you to enter your mortgage balance and your mortgage term or amortization period, as well as your property tax and your interest rate.
If you don’t know how to calculate your property tax, simply divide the value of your home by 100. Then multiply this number by the current tax rate. Here’s an example: let’s say your home is worth $200,000 and the tax rate of your area is 2.5. In this case, you could divide 200,000 by 100, which would get you 2,000. Then you would multiply 2,000 by 2.5, making your annual property tax equal to $5,000.
To calculate how much you’ll spend a month on insurance, divide your annual premium by 12.
Taking Care of Veterans
We hope this article has been helpful! If you still have questions about PITI or any aspect of the VA loan process, don’t hesitate to give us a call at 855-569-8272. Here is another helpful article on VA loan closing costs.