Mortgage lenders look at many factors when considering you as a prospective borrower, including your income and how much of it goes toward debts you’re obligated to repay. They look at your debt as a percentage of income, and they also measure how your future mortgage-related debt obligations combined with routine debt express themselves as a percentage of income. If these ratios are too high, you won’t qualify for a mortgage.
So what are these ratios? One is known as your debt-to-income ratio, or DTI, and within that, there’s a critical set of figures known as PITI, which stands for principal, interest, taxes and insurance.
Your DTI ratio includes the minimum due on all your monthly debt payments (car loan, credit cards, student loan), lined up against your monthly income. When you take on a mortgage loan, you’ll need to add its components (which are PITI) to the DTI ratio and then recalculate the formula.
Generally speaking, lenders like to see a DTI ratio of no more than 43%. Borrowers with higher ratios have a greater incidence of trouble paying back their loans. What counts as an acceptable DTI ratio level can vary depending on economic cycles, said Tendayi Kapfidze, chief economist for LendingTree, MagnifyMoney’s parent company. It also can vary under special loan programs.
“Different loan programs will have different requirements,” Kapfidze said. “The government-sponsored agencies (which buy securitized loans from banks) change ratio requirements all the time.”
What does PITI mean, and what is the importance of each component?
- Principal: Principal represents the total amount of money you’re borrowing to buy a home.
- Interest: Interest is the fee you agree to pay as a borrower, represented as a percentage when you took out your loan and applied to your monthly mortgage bill. The interest rate you secure as a borrower can vary widely, depending on market conditions, your credit score and your loan choice.
- Taxes: Mortgages generally wrap property tax into your monthly payment. Most real estate listings disclose a home’s current property tax.
- Insurance: You will need to secure homeowners insurance to satisfy lending requirements. If you’re making a down payment below 20%, you may also need to purchase additional mortgage insurance.
Why is understanding PITI so important?
Many consumers don’t understand that their future mortgage payment includes all the components represented by PITI, thus they mistakenly begin shopping for homes outside their price range or without understanding they may need to take a step back and repair their credit scores in order to get better interest rates.
“Having too high a debt-to-income ratio is one of the top reasons a buyer can fail to qualify for a mortgage,” Kapfidze said.
Roughly 1 in 4 borrowers who don’t get approved for a loan cite excessive DTI as the reason, according to a 2018 LendingTree analysis of Home Mortgage Disclosure Act data. Additionally, around 1 in 4 borrowers who fail to get a loan attribute the situation to low credit scores.
Fortunately, borrowers whose PITI figures are contributing to an excessive DTI can take action to influence their prospects. Some of these methods may take longer than others. Earning more money or raising a credit score can take time, while loan comparison shopping or investigating assistance programs can be done relatively quickly. Here are some examples:
- Earn more money. If you can earn more income in a full-time job or through side projects, you raise the figure against which lenders measure your debt. If your debts add up to $2,500 a month on a $5,000-per-month gross income, your DTI is 50%. But if you began earning $5,825 per month, your DTI would fall to 43%.
- Shop around for the right loan: Compare lenders, and you can save on interest rates. “It pays to shop around,” Kapfidze said. “You can see variations of 50 basis points among lenders on the same day.” As an example of how interest rates influence your monthly payment, consider this example: A borrower with excellent credit making a 20% down payment on a $350,000 home would pay $1,977 per month at a 4.75% interest rate — but their payment would fall to $1,894 per month at a 4% interest rate.
- Improve your credit score: The higher your credit score, the lower your interest rates as a borrower — and the lower monthly interest you’ll pay on a loan. By reducing debt, paying bills on time and letting time pass after opening credit accounts so that they “season,” you can improve your credit score. If your credit score is at or above 800, however, improving it further may not influence rates, Kapfidze noted.
- Borrow less: Borrowing less to buy a home lowers your principal. If you can make a higher down payment or are eligible to receive down-payment assistance (via a gift, seller contribution or through state or local assistance programs), or if you can find a lower-priced home, you’ll lower your principal.
- Leverage assistance programs: Many states offer down-payment or closing-cost assistance programs, or reduced or waived mortgage insurance programs, which can help improve PITI and DTI ratios.
How to calculate PITI
You can use LendingTree’s mortgage calculator to model your future estimated monthly mortgage payment on a home with a few data points: ZIP code, home price, down payment and your credit score. By entering these figures, you can come up with a potential total payment and how much of it consists of principal and interest, property taxes, homeowners insurance, homeowners association dues (if applicable) and mortgage insurance (if applicable).
If you want a more accurate estimate of your monthly payment, you can use advanced settings on the calculator to model costs based on your loan term (30-year, 15-year, etc.), a quoted or estimated interest rate you expect on your loan, the exact amount of property taxes associated with the property you plan to buy and insurance rates you’ve been quoted.
The earlier that consumers learn about PITI and how it works, the more empowered they are to succeed as borrowers.
Fortunately, lending parameters set by government-sponsored entities aren’t expected to shift dramatically in the years ahead.
“I don’t anticipate any changes this year,” Kapfidze said. “Mortgage delinquencies are at very low levels, so lending standards shouldn’t tighten up unless we encounter an unexpected economic shock.”
This article contains links to LendingTree, our parent company.