Remove PITI Confusion

[Christian Malesic]

I have been reading many posts lately where PITI is not fully understood and the nuances of its application to investments property are understood even less. Let me take a stab at clearing some of this up.

P = Principle
I = Interest
T = Taxes (Property taxes only)
I = Insurance

It is usually referred to as such because of residential owner-occupied (OO) property, it is common for the bank to make you keep an escrow account with them that includes TI. Thus, your payment each month to them is PITI. PI on the loan and TI to the escrow.

The second part (TI) is calculated by taking the homeowners insurance premium which is paid once per year and the property tax which is also paid once per year (through it can be a little more complicated, see below) and dividing by 12. They then add a federally accepted overage which by law can be up to 15% (they must eliminate this if you tell them you do not want them to include it). It is wise not to have the overage as the bank keeps all of the interest made on the escrow account. Why then should you give them extra overage money ‘just in case’ taxes or insurance goes up next year? Put a couple of bucks in your own savings account for this reason and you make the interest. Thus TI is normally computed as: ((T + I) / 12) X 1.15

Property Taxes can be a bit more complicated as alluded to above. It is not uncommon to have three different property taxes all paid at different times of the year. For example, (1) school property tax, (2) county property tax, and (3) city, borough, or municipality property tax. The concept above remains the same, the formula just gets a little more cumbersome: ((T1 + T2 + T3 + I) / 12) X 1.15

Thus, PITI was developed for OO property. Investment property can be much different.

Many lenders do not require investors to have an escrow account with them for TI; thus it is up to the investor to open a savings account and put 1/12th of their property taxes and insurance in that account each month. Many an investor has gone bankrupt for failing to do exactly that. I own a property bought at auction where that exact situation had happened. In fact, I bought 3 properties at great prices because of the poor planning on the part of that one investor. I since have sold 2 and only have the 1 left (I was given offers I couldn’t refuse for the other 2). Keeping your own escrow account is a great idea as it makes your Income Statement look superb to lenders. They sometimes forget about their own suggestions (escrow account) and when you have one with $20k in it, they look very favorable upon your ‘cash on hand’ and business-savvy practices not realizing that it is all current assets by GAAP standards; meaning you will expend it all in less than 12 months when the tax bills and insurance bills come in the mail.

There is much more…. This post has already gotten long. I will throw it out there for questions and comments.