P.I.T.I is an acronym which represents the carrying cost of owning a house and is comprised of “Principal”, “Interest”, “Taxes”, and “Insurance.” PITI is very important as it relates to something referred to as a “seller rent back.” This article will briefly discuss what a “seller rent-back” is, and then briefly individually discuss the component parts of PITI.
WHAT IS A SELLER RENT BACK?
There are situations where a homeowner wants to sell their home but needs to remain on the property for a period of time. Common situations where this can arise include: (1) The sellers are in escrow on their next home, but it will not close until after they have sold their home – utilizing a seller rent back term allows the seller to remain in the home for a specified time, while paying the new owner “rent”, (2) The sellers have sold their home, but they do not want to move until the end of the school year – the sell rent back term would allow the seller and their children to remain at the house until the end of the school year in exchange for “rent.”
Since the “seller rent back” term is a clause in an agreement that the seller and buyer must negotiate, it is possible that the seller may have to make a few concessions in order to induce the buyer to give them their preferred terms. Ultimately however, the seller will need to pay the new owner “rent”, which is generally computed using the buyer’s P.I.T.I. A caveat is necessary here – since the P.I.T.I is based on the buyer’s mortgage, and the value of the home at the time the buyer purchases it, it is entirely possible (even likely) that the P.I.T.I rent for purposes of the “seller rent back” term will be higher than the current owner’s P.I.T.I. This leads us to the meat of this article, what exactly is “P.I.T.I.”?
WHAT IS P.I.T.I.?
As mentioned above, “PITI” stands for “Principal,” “Interest,” “Taxes,” and “Insurance.” So, let’s take a look at each individual component of “P.I.T.I.”
(1) PRINCIPAL
In short, the “Principal” portion of “P.I.T.I.” is comprised of the principal on your mortgage payment, the money you borrowed in order to purchase the home, divided over the lifetime of the loan (10, 20, 30 years).
EXAMPLE:
Bob purchases a home in Studio City, California for $1.5M, he puts down 20% ($300k) and borrows the balance of $1.2M from the bank. The bank gives Bob a 30-year mortgage at 5% interest per year. The principal payment on Bob’s mortgage will be approximately $3,333.33 per month.
(2) INTEREST
The “Interest” portion of “P.I.T.I” represents that additional money you owe on the principal of your mortgage, based on the terms the bank gave.
EXAMPLE:
Bob purchases a home in Studio City, California for $1.5M, he puts down 20% ($300k) and borrows the balance of $1.2M from the bank. The bank gives Bob a 30-year mortgage at 5% interest per year. The principal payment on Bob’s mortgage will be approximately $3,333.33 per month. At 5% per year Bob’s interest is approximately $166 per month.
(3) TAXES
The “Taxes” portion of “P.I.T.I” refers to the property taxes associated with your lot, this amount is dependent on the area’s tax rate as well as the nature of the property itself. Specifically, the value of your property (based on an appraisal) and any improvements you have made on the property, will be considered in determining the amount of property taxes attributed to the home for purposes of “P.I.T.I.” in the “sell rent back” scenario.
EXAMPLE:
Bob purchases a home in Studio City, California for $1.5M, he puts down 20% ($300k) and borrows the balance of $1.2M from the bank. The bank gives Bob a 30-year mortgage at 5% interest per year. The principal payment on Bob’s mortgage will be approximately $3,333.33 per month. At 5% per year, Bob’s interest is approximately $166 per month. For sake of math, the property tax is 2%, and the assessed value of the property is also $1.5M. The annual taxes on the property will come out to $30,000, which is approximately $2,500 per month.
(4) INSURANCE:
The “Insurance” portion of “P.I.T.I.” represents the cost of protecting the home against damage or loss as a result of any number of causes. If you are making a down payment of less than 20% on your home, you will be required to carry “private mortgage insurance”, which serves as additional, secured, collateral to protect the bank against loss on their loan. The cost of this insurance varies. So, let’s tie it all together.
EXAMPLE:
Bob purchases a home from Sally in Studio City, California for $1.5M, but Sally would like to remain at the house for 1 month after the sale is complete so her son can finish the school year; Bob and Sally negotiate a “seller rent back” provision and want to determine what the “rent” for the month should be. Bob put down 20% ($300k) and borrowed the balance of $1.2M from the bank. The bank gave Bob a 30-year mortgage at 5% interest per year. The principal payment on Bob’s mortgage is approximately $3,333.33 per month. At 5% per year Bob’s interest is approximately $166 per month. For sake of math, the property tax is 2%, and the assessed value of the property is also $1.5M. The annual taxes on the property will come out to $30,000, which is approximately $2,500 per month. As such, utilizing the “P.I.T.I” measurement, Sally would need to pay Bob $3,333.33 + $166 + $2,500 + insurance, or $5,999 + insurance, for the month she wishes to remain on the property with her child.
At the Chernov Team we understand that everyone selling their homes has their own unique circumstances and needs. The Chernov Team also recognizes that if someone wants something, it can be worked into a contract provided it is fair to everyone. The “sell rent back” option is a very useful term to include for some sellers, and we pride ourselves on understanding the nuances of real estate. At the Chernov Team we understand that whoever comes to the table most prepared leaves the table with the most, and the Chernov Team always leaves the table with most.