The mortgage industry loves acronyms, with APR, ARM, and LTV being just a few examples. As a borrower, you don't necessarily need to familiarize yourself with all of these terms. However, there is one mortgage acronym that you absolutely should know: PITI. PITI stands for principal, interest, taxes, and insurance, and it has a significant impact on your mortgage.
Principal
The principal refers to the total amount of your home loan. For example, if you purchase a house for $500,000 and make a $50,000 down payment, your mortgage would be $450,000. This $450,000 is your principal, which you will pay off over the course of the loan. The principal is the largest component of PITI and represents the major portion of your monthly mortgage payment.
Interest
Mortgage lenders charge interest on every home loan they extend, and this is factored into your monthly payments. When you calculate your housing costs using a mortgage calculator, you'll see that a significant portion of your payment goes towards loan principal and mortgage interest. It's important to check current interest rates before selecting a lender, as refinancing at a later date to take advantage of lower rates may be possible.
Taxes
Property taxes are an essential expense for every homeowner, and they are usually included in your monthly housing costs. Each payment you make includes a portion set aside in escrow to cover your tax obligations. Typically, this monthly portion is 1/12th of the expected annual tax bill. When tax season arrives, your lender will use the funds in your escrow account to pay any property taxes you owe.
Insurance
Mortgage lenders require borrowers to have homeowners insurance in place before approving a home loan. Homeowners insurance provides coverage in case your house is damaged by fire, storms, or other hazards, while also helping replace lost, stolen, or damaged possessions. Similar to property taxes, the insurance premium is divided into 1/12th monthly payments and held in escrow to ensure there are sufficient funds to cover the bills.
What does PITI mean for your mortgage?
Understanding PITI is crucial when determining your monthly housing costs and how much house you can afford. Many people make the mistake of calculating their monthly housing costs by simply dividing the expected principal by the number of months in their loan term. However, this doesn't take into account property taxes, homeowners insurance, and interest payments. To accurately determine how much you can spend on a new house, use a reliable home affordability calculator that includes PITI.
Lenders also consider your expected PITI when processing your mortgage application to ensure you can afford to repay the loan. While PITI is not the only factor they consider, it is a significant one. Lenders prefer PITIs that represent a smaller percentage of your income. Although the general guideline is for PITI to be no more than 28% of your gross monthly income, lenders may accept a higher percentage depending on your total debt picture. If you have a lot of existing debt, such as auto loans, credit card bills, and student loans, lenders may hesitate to approve applications with high housing costs.
Ultimately, PITI is the key measurement for determining your monthly housing costs and plays a crucial role in determining the type of mortgage you can qualify for.
How is PITI calculated?
Calculating PITI involves breaking down each component mentioned above. You need to consider details such as your down payment and the loan amount you require. Here is a breakdown of each component:
- Principal: Subtract your down payment from the purchase price to determine the loan's principal.
- Interest: Use a mortgage payment calculator to estimate your interest payments. Input the loan amount, interest rate, loan type, and length to get an estimate. Check current mortgage rates to get an idea of the interest rate you may receive.
- Taxes: Property taxes vary across different housing markets. Research property tax information specific to your real estate market. Divide the annual tax figure by 12 to determine the monthly cost.
- Insurance: Homeowners insurance premiums depend on various factors such as the age of the house, proximity to flood zones, and insurance claims history. Contact your insurance company for a quote on a specific property you are considering.
Add these four expenses together to calculate your PITI. To understand the impact on your budget, divide your PITI by your gross monthly income. While the guideline is for PITI to be around 28% of your income, it's essential to consider other financial factors when determining a comfortable budget.
Don't overlook other housing costs
While PITI represents the bulk of your housing costs, there are other expenses to consider. These additional costs may impact your ability to comfortably pay your mortgage each month. Here are some examples:
- PMI (Private Mortgage Insurance): If you put less than 20% down on your home purchase, you may be required to pay PMI until you have gained at least 20% equity in the property. FHA loans have different rules, with PMI payments continuing throughout the life of the loan.
- Flood insurance: Homeowners insurance may not cover damage caused by rising water. If your home is located on a flood plain, you may need additional flood insurance. Check your local government's resources for information.
- Extra hazard insurance: Standard homeowners insurance covers typical hazards, but additional coverage may be needed for specific environmental disasters such as earthquakes, sinkholes, landslides, or hurricanes. Additional insurance policies can increase your monthly housing expenses.
- HOA fees: If you are purchasing a condo or moving into a deed-restricted community, you may have to pay homeowner's association dues. These fees typically cover various expenses, such as maintenance, utilities, or beautification projects. HOA fees are usually paid separately from your mortgage.
How much PITI can you afford?
Creating a housing budget is a fundamental step in the homebuying process. Although lenders may approve loans with PITIs as high as 43% of your gross monthly income, it's important to consider your overall financial situation. Other expenses, such as car loan payments, health insurance premiums, utilities, groceries, savings, investments, credit card debt, and student loans, should be factored into your budget.
If your current PITI payment doesn't fit your budget, you may need to reassess your home search. Explore less competitive real estate markets where your dollars can stretch further.
In conclusion, PITI is a crucial concept in real estate that encompasses most, if not all, of your housing costs. When budgeting for your monthly mortgage payments, it's essential to consider each component of PITI: principal, interest, taxes, and insurance. Lenders review your expected PITI when evaluating your loan application, so keeping housing costs within a manageable range is important. It is wise to consult with an experienced mortgage expert to understand your financing options and qualify for the right loan.
