It’s a PITI.

How did so many smart people get it wrong?

The ambitious mortgage rescue plan offered by the Obama Administration appears to miss a couple of critical elements which could -- unless corrected as details emerge -- leave the plan dead on arrival, and that would be a pity.

Indeed PITI is at the root of the problem.

In mortgage parlance, PITI represents Principal, Interest, Taxes and Insurance: the components of the monthly mortgage payment. Typically, according to knowledgeable insiders, the latter two elements -- real estate taxes and homeowner’s insurance -- represent about 1/3 of the monthly payment. Lenders generally require borrowers to pay those expenses monthly into an escrow account to ensure property taxes will be paid -- or, in the event of damage, that the property (collateral for the loan) is protected.

PITI -- with some other factors -- is the numerator in the equation used to determine the target percentage of a borrower’s income under the Administration’s plan to make mortgages affordable.

The arithmetic using the examples offered by Treasury to illustrate the Homeowner Affordability and Stability Plan suggests the goal of bringing the monthly payment down to 31% of gross (pre-tax) monthly income may be illusive at best.

In addition to PITI, mortgage lenders include all mortgage payments -- including those for home equity lines of credit and home equity loans -- in computing the ratio. The Homeowner Affordability and Stability Plan, or HASP, doesn’t address those obligations. 

These omissions not only could be, but are, significant.

Mortgage payments are calculated using three factors:

• The interest rate,
• The amount of the loan and
• The length of the loan.

Tweaking any one of them could change the monthly payment -- with a different outcome

Let’s take the example offered by the White House in the fact sheet it distributed when the HASP was unveiled:

“For a sample household with payments adding up to 43% of his monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38% of his or her income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31%. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. That lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs.”

The monthly payment on a $220,000, 30-year mortgage, assuming an interest rate of 6%, would be $1,319. On top of that, the typical borrower would have to pay about $660 for taxes and insurance each month for a total payment of $1,979. If that were 43% of income, it would mean income of about $4,600 a month or $55,200 a year (which is higher than the $50,200 median household income).

HASP pre-supposes the mortgage loan term will be extended to 40 years -- which has its own set of costs to the borrower.

Since the tax and insurance piece of the monthly payment is fixed, only the principal and interest payment can be reduced and would have to come down to $767 a month. To bring the mortgage payment down to that level, either the interest rate would have to be slashed -- not merely cut -- to 2.8% or the loan amount reduced to about $140,000. That low rate would remain in effect for five years

The arithmetic offered in explaining the plan doesn’t work: the new payment would have to be $552 a month lower, far more than the $400 promoted in the plan. It would require even a greater level of taxpayer funds than the President suggested.

One other factor left out of the plan is any second mortgage the borrower might have. Lenders, in computing the payment ratio, have to add all mortgage debt including payments on a home equity line of credit or home equity loan. The documents provided by Treasury for borrowers who are risk of foreclosure note only the first mortgage is eligible for a modification. That exclusion could also hamper, and perhaps doom the proposal.

The plan is a key element in the economic recovery efforts undertaken by the White House. That it may not have been fully thought through is a pity -- or, a PITI.

Mark Lieberman is the senior economist for the Fox Business Network. Prior to joining FOX, he served as first vice president and manager of economic analysis and research at Washington Mutual in New York. Before that, he served as senior vice president at Dime Savings Bank of New York (which was later acquired by Washington Mutual), where he specialized in credit and risk management. He is a member of the Executive Committee of the New York Association for Business Economics. He has a degree in Economics from the Wharton School of the University of Pennsylvania.