Sounding just like ‘pity,’ PITI stands for Principal, Interest, Taxes and Insurance. The term is used in relation to mortgage payments. It is the total monthly sum paid for a mortgage in the USA. Here is a description of the initials in the acronym in more detail.
The principal is the capital sum you owe your mortgage provider. It is the balance paid to you for the price of your home once you have made your down payment. If you purchase a $300,000 home, and put 5% or $15,000 down, your lender provides the balance of $285,000. That is the principal.
Your monthly mortgage payment will include an element of principal repayment. However, depending on the type of mortgage you have, this repayment will not necessarily be an equal part every month until the loan is repaid. Many loan repayments are interest rich to begin with and principal rich towards the end of the repayment period.
The second letter of PITI stands for interest. Your mortgage interest rate is very important, although the ‘I’ represents the actual monthly sum you pay rather than the interest rate itself. Roughly, 4% per annum on a $285,000 loan amounts to $11,400. Paid monthly this would come to $950 monthly for the first year just to pay the interest. However, there are many ways to calculate mortgage interest, and generally mortgages are fully amortized today (see below).
Mortgage amortization is a way of arranging mortgage repayment so that the borrower is paying the same monthly amount over the entire period of the mortgage. Initially, the majority of the monthly sum will be paying interest, and towards the end it will be paying the principal.
Let’s take the above example of a $285,000 mortgage at 4% interest over 30 years. Without amortization, the initial payment would be $950 for interest at 4% and $791.67 principal (285,000/30/12). Total first payment is $1,741.67 pretty hefty!
With amortization, the payment would be $1,360.63 each month for 30 years. The borrower knows exactly what he or she is paying and for how long. Another advantage is that at a fixed interest rate, this will never change, even if inflation devalues the dollar and increased income makes it easier to pay.
With this example, $950 of the first payment will be for interest with $410.63 for the principal. The final payment, 30 years later, would be $4.52 interest and $1,356.11 as the final principal payment. Total paid for the $285,000 mortgage: $489,826.80.
PITI: ‘T’ for Taxes
The tax in question is property tax. Since property tax in the USA is applied at local level, rates will vary across the country. The average rates lie somewhere between 0.2% and 4% of the value of the home. It comprises a building value and a land value. Its purpose is to finance local amenities such as education, police, fire services, local government etc.
The ‘I’ of PITI stands for ‘Insurance.’ The main insurance for mortgages with less than 20% down payment is Private Mortgage Insurance (PMI.) This insures the lender against non-payment of the mortgage. The home will be foreclosed and sold. The PMI is designed to protect the lender against the selling price being less than the equity of the property.
The policy payment is paid monthly into an escrow account along with the taxes and used to pay the annual payments. Other forms of insurance may also include homeowners insurance and fees to a homeowners association.
Many lenders will use multiples of the PITI as a minimum monthly asset the prospective buyer must have in order to qualify for a mortgage. This makes sure that if the borrower loses income temporarily for any reason, there are sufficient funds available to pay the entire PITI for several months.
Lenders should also be aware of the PITI and make sure that this is easily payable before taking on a mortgage. Mortgages involve more than just the mortgage payment itself. Some only realize this at the last minute, and lenders are generally sufficiently responsible as to prevent such people making a bad judgment call.