What is PITI?
PITI (pronounced “pity”) is an acronym for the principal, interest, taxes and insurance that make up the sum of a mortgage payment. Principal pays down the loan balance; interest is the cost of borrowing; taxes are the property taxes; and insurance includes homeowners insurance and mortgage insurance, if applicable.
Frequently, first-time home buyers shopping for a new home might only factor into their budget potential mortgage payments (principal amount borrowed plus interest) without considering that the cost of home ownership also includes property taxes and homeowners insurance, whether it is billed and paid separately or paid through the mortgage lender. When obtaining quotes from prospective mortgage lenders, it is important to make sure one is comparing apples to apples – compare PITI with PITI or compare just the principal and interest payments. Here is a closer look at how each PITI element breaks down and what you need to know.
What is Principal
This is the total amount of money you borrowed from the lender in order to make your home purchase. Typically this amount will be the sale price of the home minus any down payments you made. If you purchased a home for $200,000 with 5 percent down ($10,000), then your mortgage principal would be $190,000. As you pay down your loan each month, a portion of your payments goes toward reducing this principal.
On some occasions one might have an interest-only loan, in which case payments go toward the interest first for a set period of time before a portion of the payments also start to go toward paying down the principal.
When a portion of your payment goes toward the principal and a portion toward the interest (and taxes or insurance), this means your payments have been amortized. You can pay off your principal early (in some cases there is a pre-payment penalty for paying it off too early.) Here are two possible scenarios.
- Say you have a fixed rate mortgage amortized over 30 years (i.e., a 30-year mortgage) and are making payments to your lender every month, but seven years after purchase you decide to sell your home or refinance. The new lender you use for the refinance, or the buyer of your home, pays off your lender. Technically, this is pre-paying your principal by paying off that mortgage before the 30 years. However typically you just hear “pay off” of the loan.
- Most mortgage loans allow you to make extra payments per month. Say you want to put an extra $50 per month toward your mortgage payments, or once per year you want to write one extra payment to help you pay down your loan more quickly. Typically that means you want this payment to be applied toward your principal. By reducing your principal a bit extra per year you could effectually pay off your loan sooner than 30 years. On average, making one extra payment per year, every year, will take about 8 years of the life of your loan and you’ll have it paid off in about 22 years instead of 30. (Read more about saving on interest in the “Interest” section).
What is Interest
Interest is the amount the lender charges the borrower for them giving the loan to make the purchase. The common types of interest of fixed-rate, adjustable rate month (ARM) and no-interest loans. A fixed-rate mortgage means the interest rate will not change over the life of the loan. An adjustable rate mortgage means the rate will fluctuate based on the prime rate and a standard percentage the lender adds on. For some, ARMs, the rates will only adjust upward, meaning if the prime rate goes down, your mortgage rate remains unchanged rather than dipping along with the market. Regardless of the type of interest rate you have, the interest accrues each month on the unpaid principal balance.
The sooner you pay down the balance, the less interest you have to pay. If you have a $200,000 30-year mortgage loan with a fixed rate of 4.5 percent this means over the life of the loan you’d have paid nearly $365,000 ($165,000 of it in interest!). But if you make an extra $100 per month in payments toward principal from day one, you’d have paid off the loan in 25 years and shaved nearly $32,000 off the amount of interest you would have had to pay. However had you waited until year 10 and started paying $100 per month toward principal, you only would have saved $12,663 in interest and paid the loan off just under 3 years early. Same scenario put paying $50 per month from month one you’d still pay off the loan in just under 3 years, but you would have paid less in interest because you would have started knocking the principal down sooner. Your interest savings: $17,700. The interest rate you pay on a loan depends on several factors as weighed by the lender.
The better your credit history, the lower interest rate you may receive. The higher your down payment, possibly the lower the interest rate you’ll pay (because for the lender, that means it has a stake in a home with a higher equity value. Should you default and it takes the home, they have a smaller investment in something worth a more than they had to put in.) Shorter term loans, also get better rates because it takes less time for a lender to recoup its investment. So, you’re likely to get the best interest rate if you have a perfect credit score and clean credit history, choose a shorter-term loan (such as 15-year instead of 30-year), and if you put down, say, 20 percent instead of 5 percent. A portion of the interest you pay each year is tax-deductible on your federal returns.
What are Taxes
Taxes refer to the property taxes you have to pay to your county. In some cases you pay these directly to your tax assessor’s office, but often mortgage lenders prefer to escrow them and pay them on your behalf so that the lender knows the taxes are getting paid each period. Although for your lender to pay the taxes on your behalf seems like a convenience for you — you only have to write one check each month — in reality the lender is only concerned about its bottom line. That’s because if you don’t pay your taxes, the government can foreclose on your home and leave the lender in the lurch. The lender’s investment is gone for far fewer dollars missed than it has already invested and the lender can’t easily recoup any delinquent payments you may have had on your mortgage. A portion of your property taxes are tax-deductible.
What is Insurance
This refers to homeowner’s insurance that you have to pay based on the value of your property and the likelihood of replacing it or fixing it in some way should it become structurally damaged (say be hail, wind, fire or some other external sources. Theft is also typically covered by your homeowners insurance.)
The mortgage lender also has an interest in paying the insurance premiums on your behalf so that it can protect its own financial interests in your property. In fact, the lender is likely to require you to have hazard insurance coverage. It is basically more of your lender’s money that is likely to go up in flames should the house catch on fire. Although flood insurance or insurance that would cover a natural disaster often is add-on coverage, if you choose this coverage your lender will also collect these payments in escrow as well to pay the insurer. The lender is the only likely to require the flood insurance should you live in a flood zone.
In some cases private mortgage insurance is also paid through your PITI. Not every borrower has to pay PMI, but typically those who put down less than 20 percent toward the purchase will have to. And under new FHA regulations, a similar mortgage insurance premium has to be paid throughout the life of the loan on any FHA-backed mortgage loan. PMI is not a loan to protect your interests if you cannot pay your mortgage; instead it helps the lender recoup its costs should you become unable to pay your mortgage.
Your insurance rate can change based on your premiums, thus effecting your monthly payments. You can also switch insurance companies and shop around for a better rate, as you choose your own insurer even though the lender escrows the payments and pays the insurance company in most instances. The lender will be notified and will adjust your payments if there is a change in your premium.