What is PITI?
If you are a prospective homebuyer, you may encounter lingo and terms throughout the buying and financing process that are confusing. It can be tempting to dismiss what you don’t understand, but doing so can hurt you down the road. One term that you will come across and will need to understand is PITI.
In this article, we’ll cover what PITI is and how it affects you as a buyer.
What is PITI?: A breakdown
PITI is an acronym for the four components of a mortgage payment: principal, interest, taxes and insurance. It is seen as a total or complete mortgage payment.
Prospective buyers often incorrectly assume they can afford a home because they only look at a portion of the potential payment — their principal loan payment, said Deborah Moxam, a loan consultant and senior vice president of commercial lending at ISOE Commercial Capital in Hamden, Conn.
Moxam cautions buyers to beware of ads that promise homeownership for “less than you pay in rent” or for “only a few hundred dollars,” because typically they refer to the principal and interest of the loan only.
“People are lured in by a low monthly payment but don’t realize it does not include insurance and taxes. When it’s all said and done, the final payment can be double,” she told LendingTree.
To avoid sticker shock, Moxam stresses the importance of focusing on PITI when shopping around for a home and financing.
Here is a breakdown of each component.
The principal portion of a mortgage payment is the amount you borrow from the bank or lender spread over the life of the loan.
If the home you are purchasing costs $200,000, and you are putting down 10%, or $20,000, then the principal is $180,000. If you are not putting any money down and are financing the entire purchase, then the principal is $200,000.
Depending on the term of the loan (15 years, 30 years or another term), a portion of the principal is paid off with each monthly payment. During the initial years of paying off the mortgage, very little will go toward the principal each month, but as the loan ages, more and more of each payment will go toward paying down the principal or loan balance.
The amortization schedule of the loan will break down exactly how much of each payment will go toward the principal. You can reduce it further by making additional or larger payments and instructing your lender to apply them to the principal.
The interest portion of a mortgage payment is the amount your bank or lender charges you to borrow from them. It is the price you pay for financing the purchase of a home and is the fee the bank receives for extending credit to you.
Using the same hypothetical loan as above, the total interest on a $200,000 30-year mortgage at 5% APR is $186,512. It drops to $167,860 with the $20,000 down payment.
Like the principal, interest is spread over the entire loan term. During the early years of the mortgage, a majority of each payment will go toward the interest and will decrease as the loan progresses and more of the principal is paid down. The total amount of interest paid on the loan can be reduced by paying off the mortgage ahead of schedule.
A portion of your mortgage payment will go toward real estate or property taxes and is paid to your local government. What you pay depends on multiple factors including your city’s or town’s tax rate and the property itself.
Real estate taxes are based on the assessed value of the home, which can be higher or lower than what the property appraised for at the time of purchase and can change throughout the life of the loan whenever your locality assesses home values. Any improvements or significant changes made to your home or property will affect the amount you pay in taxes.
If the property tax rate on the home in our example is 2% and the assessed value also happens to be $200,000, then the annual taxes due would be $4,000, adding $333 to your monthly payment.
The tax portion of your payment will be held in an escrow account and is sent to your town or city by your lender when taxes are due.
Homeowners insurance protects your home and property in the event of theft or damage. Depending on the property and where you live, you may need to take out additional protection such as flood insurance.
Moxam, who was a residential loan officer for over 10 years, urges prospective buyers to find out early in the process if they need additional types of insurance, as it will affect the affordability of the home. “People have lost their qualification because we find out after appraisal that the home is in a flood zone,” she said. “Know your location and know your property.”
As with real estate taxes, the portion of your mortgage payment that goes toward homeowners insurance is held in escrow and is sent to the insurance company by your lender when the premium is due.
If you are putting less than a 20% down payment on your home, then you will also be required to carry private mortgage insurance (PMI), which is insurance that protects the lender in the event you default on your loan. It is a percentage of the loan amount charged annually and divided among the monthly payments.
As you make payments on the loan and build equity in the home, you will have the ability to drop PMI.
How to calculate PITI
As you are home shopping, it’s crucial to estimate your payments to compare the affordability of different properties you are considering.
This mortgage payment calculator will help you figure out your total payment.
You will need to have an idea of the prospective interest rate you will be paying, your town’s tax rate, as well as what you will pay in monthly PMI if applicable, which your lender can tell you.
With the calculator, you can play out multiple scenarios based on various down payments and home prices, and see an estimated amortization schedule for each scenario.
Why PITI matters
Calculating PITI is an essential part of the loan approval process for both borrowers and lenders.
As a borrower, focusing on PITI and not just the principal and interest of your loan will give you an accurate picture of the cost of homeownership.
For example, if we calculate just the principal and interest on the $200,000 home we’ve been using as an example, the monthly payment will be $966 based on a 5% interest rate and a $20,000 down payment. When calculating PITI, the payment jumps to $1,476, based on a 2% property tax rate, $1,000 annual home insurance premium and estimated PMI.
Even if you will be paying your taxes and homeowners insurance directly to your local municipality and insurance company respectively, calculating the total monthly commitment will help you be more realistic about what you can afford.
For lenders, PITI is the figure that is used during the loan approval process. “It’s important because it’s how we determine if an individual or couple can qualify for their home. We have to look at the whole package,” Moxam said.
Lenders may also take into consideration the amount you will need to pay for condo or HOA dues, although those fees are not typically included in mortgage payments.
Your bank or lender will look to make sure the estimated PITI payment does not exceed a certain percentage of your income, which is called the front-end debt-to-income ratio. To calculate it, you take the mortgage payment and divide it by your gross monthly income. The exact percentage your lender will allow depends on the type of loan you are applying for.
Lenders will also use the PITI payment to calculate the back-end or total debt-to-income ratio, which is the sum of the future mortgage payment along with any other debt obligations you have (car loans, student loans, credit cards etc.) divided by your gross monthly income.
Other things to consider
In addition to knowing the projected PITI payment on your prospective home, it’s critical to also consider the other costs associated with homeownership when determining what you can afford.
Even if your bank or lender approves you for a specific loan amount and monthly payment, it will be to your benefit to estimate the expenses that won’t be a part of your loan payment such as utilities, maintenance and repairs of the home.
If you are unsure of what to project for utilities, the current homeowners can give you an idea of their average costs. For maintenance and repairs, a good rule of thumb is to set aside anywhere from 1% to 5% of the home price annually, depending on the age of the home. So, in the case of the $200,000 home, that would be a range of $2,000 to $10,000 annually or $167 to $833 monthly.
Keeping PITI along with the additional costs of homeownership in mind will help you be more practical about how much home you can afford and will set you up for a realistic entry into homeownership.