PITI and Escrow: Mortgage Terms Explained
If you’re shopping for a loan, you may have heard the acronym PITI. PITI stands for Principal, Interest, Taxes and Insurance, the four components of your mortgage payment. Here’s help understanding this important term:
Principal and Interest
This is the portion of your payment that goes towards paying off your loan. Principal is the total amount of money that you borrowed for that loan, and interest is what the lender charges you for borrowing the money.
In a fixed rate loan, the mix of principal and interest that you pay each month changes as time progresses. Typically, you pay more interest in the early years of your loan; over time, and as you pay down the loan, you pay less interest and more principal.
Taxes and Insurance
The T&I portion of the PITI equation represents the cost of property taxes and homeowner’s insurance. The lender calculates your estimated annual property tax based on the current tax rate and divides it by twelve. They do the same thing with your annual homeowner’s insurance premium and then add both to your loan’s monthly payment of principal and interest.
Taxes and insurance are house-related expenses that are not due to the lender, so why do lenders take responsibility for paying them? It’s all about protecting their investment in you and your home. If a borrower fails to pay taxes and legal proceedings are initiated, the government must be paid before the lender. In the case of insurance, if the house burns down and the borrower isn’t current on his insurance, the lender will not be paid.
Escrow
Escrow is another mortgage term related to the taxes and insurance portion of the PITI equation. Escrow is a kind of savings account where the lender stores the portion of your monthly payment slated for taxes and insurance, and out of which they pay those annual bills on your behalf. This saves you the trouble of budgeting for a potentially large bill at the end of the year. On the other hand, you don’t earn any interest on money held in escrow. And some lenders require that you keep up to two months of mortgage payment in your escrow account – which can mean an extra expense at closing. Escrow accounts may also be optional, especially if you have a 20 percent or greater down payment.
In a nutshell, PITI is the amount of money that your loan will cost you each month. It’s important to consider PITI – rather than just the principal and interest payments - when figuring out how much you can afford to borrow.
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