The acronym "PITI" refers to the total of the components that make up a mortgage payment. These components are principal, interest, taxes, and insurance. To be more specific, they include the initial principal amount, the interest on the loan, the property tax, as well as the payments for homeowners insurance and private mortgage insurance.

What is PITI mortgage? PITI is often stated monthly and compared to a borrower's monthly gross income to compute the individual's front-end and back-end ratios. These ratios are used to determine whether or not a borrower should be granted a mortgage loan. The principal, interest, taxes, and insurance (PITI) should ideally account for at most 28 percent of the borrower's total monthly income.

Understanding Principal, Interest, Taxes, Insurance—PITI

Principal

A percentage of each payment made toward a mortgage goes toward repaying the principal, which is the total amount borrowed. Therefore, the principal on a mortgage of $100,000 is also $100,000. Loans are often arranged so that the principal due amount begins at a modest level and gradually grows over the loan's term.

Interest

When you borrow money, you must pay interest as a fee (which also serves as compensation for the lender for taking a risk on you). Mortgage payments made in the loan's early years are allocated more toward the interest on the loan than they are toward the principal; the ratio progressively adjusts as more time passes. If the interest rate on our $100,000 mortgage is 6%, then the total monthly payment for principal and interest on a 30-year mortgage would be around $599.55.

Taxes

Local governments are responsible for levying real estate taxes, often known as property taxes, which are put toward funding public services like schools, police agencies, and fire departments. Taxes are computed yearly, but you may include them as part of your monthly mortgage repayments; the total amount owed is divided by the total number of mortgage payments in a given year. The payments are collected by the lender, who then places them in escrow until the due date of the taxes.

Insurance

You may pay your insurance premiums in escrow with your mortgage payments, just as you do with your real estate taxes. Private mortgage insurance (PMI) is needed for homebuyers whose down payment is less than 20% of the property's purchase price. In contrast, homeowners insurance covers the home and its contents in the event of a fire, theft, or other covered peril.

The Function of PITI in Mortgages

Because PITI shows the entire monthly payment on a mortgage, it is helpful to both the buyer and the lender to determine whether an individual mortgage is within their financial means. When determining whether or not a potential borrower is a good risk for a house loan, a lender will look at the applicant's PITI. When determining whether they can afford a certain house, prospective buyers may compute their PITI.

When calculating the front-end ratio, PITI is compared to gross monthly revenue. Although most lenders prefer a front-end ratio of 28% or less, some may allow borrowers to have a ratio higher than 30% or even 40%. For instance, the front-end ratio of PITI expenses amounting to $1,500 divided by gross monthly revenue of $6,000 is 25%.

The back-end ratio, sometimes referred to as the debt-to-income ratio (DTI), compares the principal, interest, taxes, and insurance payment (PITI) to the gross monthly income. The majority of lending institutions have a preference for a back-end ratio of 36% or less. Assuming the borrower in the previous example had two reoccurring monthly expenses, such as a credit card payment of $100 and a vehicle payment of $400, the back-end ratio for this scenario would be 33% (PITI: $1,500 + $400 + $100 / $6,000 = 33%).

Certain lenders also use PITI to calculate the reserve requirements that a borrower should have. If a borrower has a temporary drop in income, lenders demand reserves to ensure that mortgage payments will continue to be made. When quoting reserve needs, lenders will often use a multiple of PITI. A standard minimum reserve requirement is equal to two months' worth of PITI. In the previous scenario, the borrower would not be eligible for a mortgage unless they had a minimum of three thousand dollars in liquid assets, which would be held in a bank account.