An acronym is something of a verbal shortcut: a pronounceable word that is created from the first letter of each word in a longer phrase or title. The mortgage world, like many of today’s environments, is full of acronyms, and trying to figure out the alphabet soup that they create can be a bit challenging. However, understanding their meaning and the information behind them can help you prepare for homeownership. What is PITI? And why does it matter?
What Is PITI?
As the Consumer Finance Protection Bureau explains, PITI is an acronym for the four parts of a mortgage payment. Knowing what these parts are and how a lender uses them to calculate a mortgage’s affordability can help prepare you to navigate the mortgage approval process.
Breaking Down PITI
What is PITI? As The Ascent reports, it consists of four parts:
- Principal: The first letter in the acronym references the loan principal that you will need to begin repaying. The principal is the amount that you borrowed. You won’t simply repay an equal amount each month. With the way that loans are structured, most of your early mortgage payments go to interest. As time passes, the balance shifts, and more of your payments go towards the principal. If you choose to pay extra, you can indicate that this money should go toward paying down your principal balance.
- Interest: The second letter in PITI refers to interest, which is the price that you pay for borrowing money. With a fixed-rate loan, you’ll pay the same interest rate over the life of your loan. If you have an adjustable-rate loan, your interest rate, and your loan payment, may change.
- Taxes: The third letter stands for taxes, which is fitting because owning a home means paying property taxes. Many lenders require you to pay your property taxes as part of your monthly mortgage payment. In this situation, the mortgage servicer collects the funds each month and sets them aside in an escrow account until it is time to pay them. Some lenders will allow you to handle your own property taxes. Even if you plan to pay your property taxes separately, you’ll want to be prepared to calculate PITI. After all, it may offer insight into your chances of getting your mortgage application approved.
- Insurance: The final letter in PITI stands for insurance. At a minimum, it refers to the homeowners insurance that your lender will require you to purchase in order to protect your new investment. Like property taxes, homeowners insurance is often paid as part of the monthly mortgage payment and placed into an escrow account until the bill comes due. However, you may be given the option to pay it yourself if you choose. In some cases, private mortgage insurance can also be considered part of this insurance.
Why PITI Matters
Why does PITI matter? As Investopedia explains, lenders use it as a benchmark to help determine whether a borrower will actually be able to afford a home loan. They use a pair of debt-to-income ratios to help:
- The Front-End Ratio: This ratio looks at how much of a borrower’s income will go toward housing. Lenders generally prefer that it be no more than 28 percent, but up to 30 percent is sometimes acceptable.
- The Back-End Ratio: This ratio looks at how much of a borrower’s income goes toward paying all their debts. This includes their housing costs, living expenses, credit card payments, and other costs. Lenders generally prefer 36 percent or less. However, some lenders will accept a ratio up to 43 percent in certain cases.
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