By Jeff Keleher on 7/30/2021 Tags: mortgage basicsbuying a home
The mortgage industry loves acronyms — APR, ARM and LTV, just to name a few. You don’t always need to familiarize yourself with these terms as a borrower, but there are some mortgage acronyms you absolutely should know. Chief among them: PITI (principal, interest, taxes and insurance).
PITI has a huge impact on your mortgage, whether you realize it or not. It basically determines what your monthly mortgage payments will be. For anyone interested in buying a house or refinancing an existing mortgage, PITI is an acronym you should get to know.
PITI meaning: What does PITI stand for?
PITI stands for principal, interest, taxes and insurance, which are the four main components of your mortgage payment. Depending on the exact terms of your lending agreement, you may have additional expenses that are bundled into your monthly housing costs. But PITI represents the lion’s share of your mortgage payments.
Let’s break down each piece to see how PITI adds up:
The principal is the total amount of your home loan. If you buy a $500,000 house with a $50,000 down payment, then you would need a $450,000 mortgage. That $450,000 is your principal, which you will pay off over the course of the loan.
Among the four components of PITI, principal represents the single biggest ticket item on your mortgage payment. In some cases, you may hear your lender refer to the principal as the “face value” of your loan, but the two terms are essentially interchangeable.
Mortgage lenders charge interest on every home loan they extend, which is then built into your monthly payments. Run the numbers in any mortgage calculator, and you’ll see that most of the money you spend on your housing costs will go to the loan principal and mortgage interest. In many cases, lenders structure amortization schedules so interest is paid in arrears. That means your monthly payment includes the principal plus interest on the unpaid principal balance from the previous month.
Given the importance of interest in your total housing costs, be sure to take a look at current interest rates before choosing a lender. And remember, you may be able to refinance at a later date to take advantage of lower rates.
Every homeowner needs to pay property taxes, and those expenses are usually included in your monthly housing costs. With each payment you make, a portion is set aside in escrow to cover your tax obligations. Typically, that monthly portion is 1/12th of the expected annual tax bill. Then, when tax season rolls around, your lender will pay any property taxes you owe using those ear-marked funds in your escrow account.
Mortgage lenders require every borrower to obtain homeowners insurance before approving a home loan. Homeowners insurance provides coverage in case your house is damaged by fire, storms or other hazards, while also helping recoup the costs of replacing lost, stolen or damaged possessions. Payment is often handled in the same fashion as property taxes, with 1/12th of your annual premium set aside in escrow each month to cover your premiums. Keep in mind that with both taxes and insurance, you may need to prepay a few extra months at closing. This way, you’ll be sure you have enough in escrow to cover those bills.
What does PITI mean for your mortgage?
Because PITI represents the bulk, if not all, of your housing costs, it’s an extremely important concept to wrap your head around. You need to consider each expense when figuring out how much house you can afford.
Many people fall into the trap of taking their expected principal and simply dividing it by the number of months of their loan — say 360 (30 years times 12 months) for a 30-year fixed rate mortgage — to predict their monthly housing costs. But your property taxes, homeowners insurance and interest payment all add a significant amount of money to your mortgage payment. Use a reliable home affordability calculator that accounts for PITI to accurately determine how much you can spend on a new house.
PITI impacts loan approval
Lenders will also review your expected PITI when processing your mortgage to make sure you can afford to pay back your loan. PITI is by no means the only factor that lenders weigh when considering a loan application — debt-to-income ratio, existing debt and credit history are all important criteria as well — but it’s a big one.
Lenders prefer PITIs that represent a smaller percentage of the borrower’s income. An often-cited rule states that your PITI should be no more than 28% of your gross monthly income. That’s not set in stone, by any means. Lenders may be OK with a PITI as high as 43% of your income, but they’ll look at your total debt picture. If you have a lot of other existing debt, like auto loans, outstanding credit card bills and student loans, lenders will be less likely to approve applications with such high housing costs.
Still, lenders are more likely to approve your loan if your PITI is significantly lower than your take-home pay. Otherwise, if the numbers don’t add up, you can’t expect to qualify for a mortgage.
Bottom line: PITI is the most accurate measurement at your disposal to see how much you’ll pay in housing costs each month. And that will tell you both how much home you can afford and what kind of mortgage you’ll qualify for.
How is PITI calculated?
You need to break down each of the four components listed above to calculate your PITI. To do that, you may have to iron out some other details like how big of a down payment you plan to make and how big of home loan you think you will need. Let’s take a look at each piece of the puzzle:
- Principal: Subtract the down payment from the purchase price of the loan. That will leave you with the loan’s principal.
- Interest: Rather than try and figure out on your own how much interest will cost over the life of the loan, you’re better off using a mortgage payment calculator. Simply plug in the loan amount, the interest rate, type of loan and loan length to get a fairly accurate idea how much you’ll pay. Look at current mortgage rates to get a sense of what interest rate you’ll get on your home loan.
- Taxes: Property taxes vary significantly across different housing markets, and you may pay thousands of dollars more in one location compared with another. Look for property tax information covering your specific real estate market. Often, you’ll need to know the county and appraised value of the home to get the best results. If you have an annual tax figure, be sure to divide it by 12 to figure out your monthly cost.
- Insurance: Homeowners insurance premiums depend on a bunch of different factors: the age of the house, proximity to flood zones and insurance claims you filed in the past. Reach out to your insurance company to get a quote for any particular house you’re considering.
Once you have all four of those expenses, simply add them together to get your PITI. As an added step, divide the PITI by your gross monthly income to find out how much of your budget will be spent on housing costs. Remember that although the 28% figure is a general guideline, you don’t want to devote an overly large percentage of your salary to housing alone.
Don’t overlook other housing costs
PITI is an extremely important figure to keep in mind when figuring out your monthly housing costs, but it doesn’t always fully encompass all of your expenses. In some scenarios, there will be additional costs you need to account for. And while none are as expensive as the combined forces of PITI, they could impact your ability to comfortably pay your mortgage loan each month.
- Flood insurance
- Extra hazard insurance
- HOA fees
PMI stands for private mortgage insurance, which you’ll need to pay each month if you put less than 20% of the purchase price forward as a down payment. Lenders will require you to pay PMI each month until you’ve gained at least 20% equity in the property. That’s only for conventional mortgages, though. If you buy a house with an FHA loan, you’ll have to pay PMI throughout the life of the loan, regardless of the down payment size.
Homeowners insurance covers water damage caused by leaks and burst pipes, but not rising water. If you live near a river, lake, ocean or other body of water, check if your home sits on a flood plain. Listing agents should disclose if property is located in a Special Flood Hazard Area (SFHA), but you can also find this information through your local government’s publicly available resources.
Your lender will also check your home’s SFHA status and may require extra flood insurance to defray the cost of structural repairs. Plus, it’s just good sense to prepare for the worst if you live in a high-risk flood zone. Flood insurance has a reputation for being somewhat pricey, so keep that in mind when planning your housing costs.
Extra hazard insurance
Hazard coverage comes standard with just about any homeowners insurance policy, but you may want additional protection in case your home is at risk for other environmental disasters. Earthquakes, sinkholes and landslides can all be covered by separate insurance plans, for instance. Hurricanes are a bit trickier since you need to address each source of damage — strong winds and flooding — individually. That means taking out additional insurance policies, which further increase your monthly housing expenses.
If you’re buying a condo or moving into a deed-restricted community, you’ll likely need to pay homeowner’s association (HOA) dues. HOA fees can pay for anything from water utilities in condo buildings to maintenance of common areas and upkeep or beautification projects in HOA neighborhoods. Unlike the other housing costs listed above, HOA fees are typically paid separately from your mortgage and do not come out of escrow. These assessments run, on average, around $200 a month, but can go even higher than that. So, budget accordingly.
How much PITI can you afford?
Creating a housing budget is one of the most fundamental and important steps in the homebuying journey. As we noted earlier, lenders may approve your loan even if you plan to spend as much as 43% of your gross monthly income on PITI.
Devoting that much money to housing alone may not fit everyone’s lifestyle, though. You need to take a clear-eyed look at your finances to figure out what’s realistic. Here are a few common expenses that may impact your PITI:
- Car loan payments
- Health insurance premiums
- Credit card debt
- Student loans
If you need to lower your PITI payment to fit your house budget, your best options may be to simply reassess your home search. Consider looking at less competitive real estate markets where you can really stretch your dollars.
PITI is an important concept in real estate, representing most — if not all — of your housing costs. As a prospective homeowner, you need to factor in each part of PITI — principal, interest, taxes and insurance — when budgeting for your monthly mortgage payments.
Lenders will review your expected PITI when considering a home loan. Even though borrowers may get approved with a PITI as high as 43% of your gross monthly income, it’s best to keep that number as low as possible. In general, your total debt picture — housing + cars + loans + credit cards — needs to be in the 43% to 45% range. When in doubt, talk to an experienced mortgage expert to better understand your financing options and what kind of loan you’ll qualify for.
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