A Guide To PITI, Private Mortgage Insurance, and Rate Lock

Mortgage payments are usually the most strenuous investment expense homeowners incur each month. When you enter these agreements, it’s important to understand the terms you will surely come across during this journey.  

Below are some common terms regarding mortgages, and you’ll run into most if not all of them when exploring your financing options and monthly mortgage payment. PITI, private mortgage companies, and mortgage rate locks can be complex, so keep reading to learn more about these terms.  

What is PITI? PITI Real Estate Components and Financial Aspects 

PITI is one of the acronyms that may come up when you’re consulting a mortgage lender about what kind of mortgage and monthly payment you can afford.  

Banks and other lending institutions will not offer you a loan that you cannot pay back, so they have their borrowers undergo a mortgage preapproval process to determine exactly how much they can afford. PITI is a metric set forth by the bank to give borrowers an idea of what they will be offered prior to shopping around for a home.  

Now, what does PITI stand for? 

(P): Principal 

The principal of your mortgage loan is the original loan amount you owe. For example, if your house is $300,000, and you put down a down payment of $70,000, your principal amount would be $230,000. 

Of course, the infamous interest will cause you to pay back more than your original $230,000 over the lifespan of your loan. While interest rates vary, the idea is the same. Your principal amount will be made back and then some over time.  

(I): Interest 

Think of interest as the cost of borrowing money, or the rate that banks or mortgage lenders charge you for borrowing money from them. Over time, the amount of interest you pay will decrease because you only have to pay interest on the portion of your loan that you haven’t yet paid off, and that number steadily decreases. This is why interest rate is expressed as a percentage, not a set number.  

(T): Taxes 

Taxes are another unfortunate aspect of home buying. Everyone must pay taxes on their property. Taxes are a crucial part of figuring out how much you can afford, since property tax can get very expensive.  

(I): Insurance 

Lastly, the ‘I’ in PITI stands for homeowners insurance when determining your level of mortgage affordability.  

While many states do not require you to purchase homeowners’ insurance, most lenders do mandate that you get a certain baseline level of insurance protection. Some homeowners will stick with this baseline level of insurance, while others will tack on additional coverage for things like flooding or other natural disasters not covered under your original policy.  

Generally, expect to pay about $3.50 for every $1,000 your home is worth.  

Importance in Real Estate Investment 

Knowing the estimates and amounts of each component of PITI helps you plan and manage overall housing costs, guiding informed decisions, and preventing financial strain. 

By calculating PITI accurately, you can assess property affordability and stay within budget constraints. This understanding minimizes stress and avoids overextending financially. 

Incorporating PITI into your budgeting process aids in efficient house hunting and ensures that insurance costs and property taxes align with your monthly financial plan. Make PITI a cornerstone of your real estate investment strategy to navigate the market wisely and secure properties within your means. 

What is Private Mortgage Insurance? The Impact of Your Down Payment 

Private Mortgage Insurance (PMI) is a type of insurance policy that lenders require from homebuyers who finance their home purchases with a conventional mortgage but have less than 20% of the home’s purchase price as a down payment. PMI protects the lender in case the borrower defaults on the loan. 

PMI is specifically designed to reduce the risk for lenders. When a borrower makes a down payment of less than 20%, the lender assumes a higher risk because the borrower has less equity in the property. PMI mitigates this risk by covering a portion of the lender’s loss if the borrower fails to repay the loan. Essentially, PMI enables buyers to purchase homes with smaller down payments while providing financial security to the lender. 

Impact of Down Payment Size on PMI 

The size of the down payment directly influences whether PMI is required and how long it must be paid. Here’s a breakdown of how the down payment affects PMI: 

• Down Payment of 20% or More: If a borrower makes a down payment of at least 20% of the home’s purchase price, PMI is not required. This substantial equity reduces the lender’s risk significantly. 
• Down Payment Less Than 20%: Borrowers who make down payments of less than 20% are typically required to carry PMI. The smaller the down payment, the higher the risk to the lender, and thus the higher the PMI premium might be. PMI premiums can vary but are generally between 0.46% to 1.5% of the original loan amount per year. 
• Cancelling PMI: PMI is not a permanent cost. Once the borrower’s equity in the home reaches 20% through either paying down the mortgage principal or an increase in the property value, the borrower can request the lender to cancel the PMI. By law, lenders must automatically terminate PMI when the borrower’s equity reaches 22% of the home’s original purchase price. 

Mortgage Rate Lock Basics and Considerations 

Our third and final mortgage term is mortgage rate lock. A mortgage rate lock allows the borrower to lock in the interest rate on their mortgage for a predetermined amount of time. This agreement is between the borrower and the lender, and it is typically based on the prevailing market interest rate at the time of the agreement.  

A rate lock is a great way to protect yourself against the unpredictable and rising interest rates in the market today. Usually, rate locks will be anywhere from 30 to 60 days. Some agreements will even let borrowers take advantage of lower-than-average market rates for their mortgage rate period.  

Keep in mind that if you correct your income or credit score, or if the information was incorrect at the time of the agreement, the lock is no longer viable, and your interest rate is subject to change. Your rate can also change if your home ends up being appraised differently than expected.  

Fallout Risk for the Lender 

While market rate locks seem like a fantastic idea to keep a great interest rate on your mortgage, what happens if interest rates go down?  

If this occurs, you have the option to leave the agreement. Leaving the agreement before your loan is closed is called fallout risk, and it is incurred by the mortgage lender. They lose out on the opportunity to profit from the borrower’s interest rate and loan fees, as well as any fees they could have owned if they sold the mortgage on the secondary market.  

Risk for the Borrower 

What are the potential risks for a borrower looking at a mortgage rate lock agreement?  

Of course, it’s possible that interest rates fall during your lock period, and you already know that you have the option to walk away if this occurs. However, if interest rates rise during your lock period, some lenders have been known to drag their feet with the paperwork process and let the lock term expire, subjecting the borrower to the new, higher market rates. 

Also, be wary of agreements with a “cap” clause. Some lenders include a “cap” with their rate lock contract, which permits them to raise interest rates if the market rates rise above a certain amount. Although you are still offered some protection since the market rates must rise above a predetermined percentage, you should be wary of any caps in your rate lock agreement.  

Conclusion 

Now that you understand the essentials of PITI, rate locks, and private mortgage insurance, you can make more informed decisions about property affordability, funding options, and securing favorable interest rates.