You may have noticed the acronym PITI pop up in your search queries if you’re on the hunt for a mortgage. What exactly is PITI, anyway? Use our comprehensive guide for everything that you need to know about your PITI ratio so you end up with a manageable and sustainable monthly mortgage payment.
What Does PITI Stand For?
PITI is an acronym that stands for principal, interest, taxes and insurance. Many mortgage lenders estimate PITI for you before they decide whether you qualify for a mortgage. Lending institutions don’t want to extend you a loan that’s too high to pay back, because this increases the chances that you’ll default on the loan or skip a payment or two. Know your estimated PITI so you can shop for an affordable home and make it easier for you to get a mortgage.
Let’s break down each of the PITI components and analyze their significance.
The principal of your mortgage is the amount that you owe before any interest is added. For example, if you buy a home worth $250,000 with a 20% down payment, your principal amount would be $200,000. However, throughout the life of the loan, you pay more than your original $200,000 because of interest. Most lenders look at your principal balance and debt-to-income (DTI) ratio when they consider whether they should extend you a loan.
Your DTI ratio is a calculation of your ability to make payments toward money you’ve borrowed. Your DTI ratio is comprised of your total minimum monthly debt divided by your gross monthly income and is expressed as a percentage.
An interest rate is a percentage that shows how much you’ll pay your lender each month as a fee for borrowing money. Your mortgage lender calculates interest as a percentage of your principal over time. For example, if your principal loan is worth $200,000 and your lender charges you an interest rate of 4%, this means that you pay $8,000 (4% of $200,000) for the first year of your mortgage in interest.
When you shop for a mortgage, you may hear the term mortgage amortization in reference to your interest and principal payments. Amortization is a scale that tells you how much of your monthly mortgage premium is applied to the principal of your loan and how much goes toward interest.
At the beginning of your loan, most of your mortgage payments cover interest instead of principal. As your loan matures, the amount of interest you pay decreases because the principal decreases – you only have to pay interest on the portion of the loan that you haven’t paid off.
For example, you may pay $8,000 in interest on the first year of your $200,000 mortgage, but by the time your principal decreases to $50,000, you pay only $2,000 annually (4% of $50,000). This is why it’s so important to choose a home within your price range – it’s easy to fall behind on payments if you can’t pay off your interest and also make progress to decrease your principal.
You must pay taxes on your property. Taxes are one of the often-overlooked costs of homeownership. It’s important to consider them when you think about how much home you can afford. The most expensive tax most homeowners pay is property tax, which may vary by location. Property taxes support the local community and pay for things like libraries, local fire departments, public schools, road and park maintenance and community development projects. It’s difficult to say exactly how much you can expect to pay in taxes because they depend upon your home’s value and your local property tax rate. Taxes can vary from year to year.
As a general rule, anticipate paying $1 for every $1,000 of your home’s value every month in property taxes. For example, if your home is worth $250,000, you pay around $250 per month in property taxes or about $3,000 per year.
Most states require that you get an official and unbiased appraisal so they can accurately estimate your taxes. Your mortgage lender usually includes the cost of an appraisal in their list of closing costs. After you sign on your home, keep in mind that your state or local government may require ongoing reappraisals every few years for tax purposes, depending on where you live.
Though homeowners insurance is not required by law in most states, most mortgage lenders require that you maintain at least a certain level of property insurance as a condition of your loan. Homeowners insurance covers your property if a fire, lightning storm or break-in occurs.
Some homeowners insurance policies include additional coverage for damage from flooding and earthquakes as add-ons. If you have something very valuable in your home, like a piece of artwork, an expensive piece of jewelry or a musical instrument, you may purchase a high-value layer of protection called a rider in addition to your standard policy. If you live in a condominium, you’ll usually pay a homeowners association fee in lieu of individual insurance that covers your dwelling.
Like property insurance, it’s difficult to say exactly how much you can expect to pay in property insurance because every insurance company uses their own unique formula when they calculate your rates. Some factors that influence your premium include:
- Your home’s value
- Whether you live in a rural area or an urban area
- How close you live to a fire department or police station
- Whether you have an attractive nuisance on your property, which is something that is likely to injure children who enter your property like a pool, trampoline or aggressive dog
- How many claims you make each year on average for other types of insurance
As a general rule, expect to pay about $3.50 for every $1,000 of your home’s value in homeowner’s insurance per year. In this example, you will pay $875 on a property worth $250,000 per year, or about $73 per month.
When you add all four components together, you get the average total cost of a mortgage per month.
How To Calculate PITI
It’s a good idea to calculate your PITI before you fall in love with a home. You can use your PITI to estimate how much home you can afford and make sure you don’t sign onto a mortgage that you might struggle to pay back. Use what you know about PITI to limit yourself only to homes within your budget.
Most mortgage lenders like lending to buyers who have a total PITI that’s at or below 28% of their monthly household budget. Try to limit your home prospects to choices that fall near that ratio. For a more accurate estimate, check with Home Mortgage Experts at Quicken Loans. Your interest rate also depends on how much you can put down for a down payment as well as your credit score.
For example, let’s say that you earn about $7,000 a month and you like a home that’s priced at $300,000 after you account for your down payment. Let’s also say that you meet with a lender who tells you that you can get a 4% interest rate. To calculate your PITI on a 30-year fixed rate loan:
- Your monthly mortgage principal and interest will amount to about $1,432.25 per month. Add on your property tax and insurance estimations.
- To calculate property taxes, divide your home’s value by 1,000 and multiply that number by $1 to find your monthly payment. In this example, $300,000/1,000 is $300, a single month’s worth of property taxes.
- To calculate your interest payment, divide the value of your home by 1,000, multiply by $3.50 and divide by 12 to find a year’s worth of insurance payments.
a. $300,000/1,000 = $300, $300 x $3.50 = $1,050, and $1,050/12 = $87.50, a month’s worth of homeowner’s insurance.
- Finally, add together all three numbers for your PITI estimation: $1,432.25 + $300 + $87.50 = $1,819.75, your PITI.
- Divide your PITI by your total monthly income to find your ratio. If you earn $7,000 a month, your PITI would make up about 26% of your monthly budget, which means that the property could be a reasonable choice for your finances.
Why Does PITI Matter?
Your PITI matters because it gives you a rough idea of how much home you can afford. Most lenders use the 28% rule as a first look when they decide whether a loan is too risky.
If your PITI makes up much more than 28% of your monthly budget, they may require you to pay for additional mortgage insurance before they sign off on your loan. If you calculate a reasonable PITI for your area before you shop, you can save both time and stress if you only consider homes within your budget.
Keep in mind that your monthly PITI may not cover the entirety of home buying costs. You may require lines in your budget for repairs, utilities and monthly maintenance, along with your mortgage payments, taxes and interest.
You also need to plan and budget for the down payment and closing costs required by your lender. Some of the closing costs you may see include pest inspections, appraisal, real estate attorney fees and title transfer costs. Make sure you think about all of these costs in addition to your PITI before you decide that a home is a good investment for you.
Understand Your Entire Mortgage Payment
Investing in a home can be one of the most exciting moments in your life or it can be one of the most stressful. It all depends upon how much research and planning you do before you sign on the dotted line. Consult with a mortgage preapproval expert or mortgage lender before you start house-hunting to learn more about your unique PITI and housing options.
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