What Is PITI? Its Meaning And What It Stands For
Andrew Dehan7-minute read
October 19, 2022
You may have noticed the acronym PITI pop up in your search queries if you’re on the hunt for a mortgage loan. What exactly is PITI, and what does it stand for?
This article can act as a comprehensive guide for everything that you need to know about your PITI ratio so you can 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 you might have trouble affording. That means it’s generally a good idea to understand the preapproval process and start working with a lender before you start shopping. Your lender can help you start the process with an understanding of what PITI you can afford so you can shop accordingly.
Now that we know the definition of PITI, let’s break down each of its components and analyze their significance.
The principal of your mortgage loan 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 ($50,000), 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. It comprises 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 $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.
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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 you can afford. One of the most expensive taxes most homeowners pay is property tax, which may vary by location.
Property taxes support your local community and pay for things like libraries, local fire/police departments, public schools, road maintenance, 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 also vary from year to year.
As a 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.
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. Most homeowners insurance plans cover 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 (HOA) fee in lieu of individual insurance that covers your dwelling.
Like property taxes, 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 or an urban area
- Your home’s proximity to a fire department or police station
- Attractive nuisances on your property, something that could injure children who enter your property (pool, trampoline, aggressive dog, etc.)
- 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.
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How To Calculate Your PITI Payment
The easiest way to incorporate PITI into your home buying journey is to get started with a lender. If you do so, your potential lender will do PITI calculations for you and let you know what you can afford.
Sometimes, though, the home buying process doesn’t go in a straight line. If you’re starting the process because you’ve spotted a home you’d love to own and don’t yet have a preapproval in hand, it’s a good idea to calculate your PITI yourself to see if it’s in budget.
Most mortgage lenders like lending to buyers who have a housing expense ratio at or below 28% of their monthly household budget. Try to limit your home prospects to choices that fall near that ratio. 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 going to need a $300,000 mortgage (after 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 estimated 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. Also, check your state government’s website to see if they have a property tax estimator. This will give you the most realistic amount for property taxes that you’ll have to pay after you buy your new home.
- To calculate your insurance 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.
$300,000/1,000 = $300, $300 ✕ $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 should be a reasonable choice for your finances.
Why Does PITI Matter In Real Estate?
Your PITI matters because it gives you a rough idea of how much you can afford to purchase a home. Most lenders use the 28% rule as a first look when they decide whether a loan is affordable.
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:
Make sure you think about all these costs in addition to your PITI before you decide that a home is a good investment for you.
The Bottom Line: Understand Your Entire Mortgage Payment
The more you understand the home buying process, the easier the process will seem. After all, buying a home can be one of the most exciting moments of your life. Working with a lender can help you understand what you can afford when it comes to PITI.
If you feel ready to take the next step, get started today with Rocket Mortgage®.
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