Understanding PITI

PITI is an abbreviation that stands for for principal, interest, taxes and insurance.  Over the life of a standard mortgage loan, usually 30 or 15 years, the entire loan amount is scheduled to be fully paid off, or amortized accordingly. In the early years of your mortgage term, the monthly payment is mostly applied toward interest and a very small percentage goes toward paying down the principal. As you continue to make payments through the years, a smaller portion of the monthly payment goes to paying the interest and a larger portion goes to paying off principal. In other words, the first payment you make will be nearly all interest but the final payment will be nearly all principal.

An estimate of annual insurance and property taxes are computed by the lender and added to your monthly mortgage payment due. The lender deposits your tax and insurance money into a separate escrow account and then uses that money to pay your tax and insurance bills as they come due.

Your monthly mortgage payment is made up of four parts: principal, interest, taxes and insurance 

• Principal is the amount of money you borrow. It is based on the sales price of the home minus the amount of your down payment. In short, principal is the amount you borrow.
  
  
• Interest, is the cost of borrowing the principal. The amount of interest you will be charged is a percent of the total amount you are borrowing. The interest percentage, or rate, can vary from lender to lender and from one type of loan to another.
  
  
• Property Taxes are due to the local government and are usually assessed annually as a percentage of your property’s assessed value.
  
  
• Insurance and taxes are not always a part of your monthly mortgage payment. With the lender’s agreement, you may opt to pay for your home’s insurance and property taxes separately. Insurance is required by the lender when you use the house as collateral for the loan during the entire term of the mortgage.

The Four C's of Application Approval

Lenders use four basic standards to approve your application for a home loan. Different loan programs have varying guidelines within those standards.  Basically, they evaluate you as a borrower based on “the four C’s”: Capacity, Character, Capital and Collateral.

Income (Capacity)

The lender will determine if you have a steady and sufficient income to make the monthly loan payments. This income can come from a primary, second, or part-time job(s), commissions, self-employment, retirement benefits, pensions, child support, alimony, disability payments, rental property income, and a variety of sources. You will be asked to show documentation to verify your sources of income.  Lenders will generally calculate your debt-to-income ratio to determine how much money they will lend. Armed with a maximum loan amount, you are ready to start shopping.

Credit History (Character)

Have you paid back the money you've borrowed in the past?  Have you been late in making any of your payments?  Have you filed for bankruptcy?  Take a look at your credit report and talk to your loan officer about how you can improve your credit score if you foresee any problems.

Savings (Capital)

The lender will verify you have the funds to make the down payment and pay for your share of the closing costs. They will also be interested in how much debt you have in the way of car loans, credit cards or other ongoing obligations.  In short, they will want to be certain that you will have enough cash flow to comfortably make your monthly loan payment.

Property (Collateral)

Finally, your lender will require an appraisal on the property you plan to own to determine its market value in comparison to similar homes that have sold recently in the neighborhood.  The appraisal amount will ultimately determine how much the lender will allow you to borrow.   Contact your Locations Agent to get more information on how properties are valued using the appraisal method.

Debt-to-income Ratios

Your debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income.  It's one of many ways lenders measure your ability to manage the payments you make every month to repay the money you borrowed.  The mortgages listed below have a set debt to income ratio that specifies the maximum amount of debt allowed to qualify for the loan. 

• Conforming loans - the debt to income ratio is 43%.  
• VA Loans - the ratio is 41% but exceptions can be made in certain situations using residual income (check with your lender).  
• FHA Loans - debt to income ratio is 31/43.  This means that 31% of your gross income may be applied to your housing expenses and 43% is the maximum amount of total debt.
• USDA Loans- loans the debt to income ratio is 29/41.  29% of your debt income may be applied to housing and 41% is the maximum debt allowed.