Buying a home is still on the to-do list of many Millennials and Gen Zers — the next two generations in line to make huge purchasing decisions in the coming years.
And that’s great for not only home buyers, developers, and a host of other professionals in the real estate industry, but it’s also great news for investors and brokers — whether they’re actively or passively invested in real estate.
It’s also one of the most significant purchases someone ever makes in their life, which means there’s a lot to consider. That’s especially true regarding monthly expenses, such as home owner’s association fees, maintenance fees, taxes, insurance premium, mortgage, water, sewer, and more.
If you’re currently shopping for a mortgage, you might’ve heard the term PITI thrown around a few times.
But if you’re new to the mortgage lending process, you probably have no idea what PITI is and how it will impact you throughout the mortgage lending process.
Let’s break it down by defining what PITI is and how important it is to home buying.
What is PITI?
PITI stands for principal, interest, tax, and insurance. It’s an estimate mortgage lenders use before deciding if you qualify for a mortgage. Knowing your estimated PITI before you start shopping for a mortgage can significantly increase your chances of getting approved. That’s because lenders don’t want to give you a mortgage you won’t be able to pay back.
Let’s take a closer look at each component of PITI, and you’ll see just how important each one is to the equation.
Principal
The principal is the portion of your monthly payment applied to your loan balance. Once you start making mortgage payments, very little of that money you pay in the beginning actually goes toward paying down the balance.
The principal also refers to the lump sum amount of money you borrow. For example, if you bought a house worth $250,000 with a 20% down payment, the principal on that would be $200,000 (the balance after you pay the down payment, in other words).
But typically, you’ll pay more than that original $200,000 thanks to interest. Lenders will usually look at your debt-to-income ratio (DTI) in addition to the principal balance when deciding whether to extend you a mortgage.
Interest
The interest rate is the rate you’re charged on a loan, and it’s based on the interest rate you locked in when you closed on your loan. The interest rate is usually the highest at the beginning of the loan term but typically drops once the balance starts getting paid down over time.
You might hear the term mortgage amortization while you’re shopping for a mortgage. This just means that an amortization schedule will tell you how much of your monthly mortgage premium is applied to your loan balance and how much goes towards interest.
If you make extra payments or choose a shorter loan term, you can pay off your mortgage faster.
Taxes
Real estate taxes (or property taxes) are one of the most overlooked costs of buying a home. But this is one of the most important payments you’ll make. If you don’t pay your property taxes, a lien could be placed on your home for failure to pay property taxes and then the homeowner risks going into pre-foreclosure.
That’s why you must pay your property taxes.
So pay attention to how much property taxes are on each home you’re considering to ensure you can afford it before getting into a head-barely-above-water situation.
You want to ensure you have enough money left over after paying taxes to tackle your other expenses.
The amount you’ll pay in property taxes will depend on several factors, such as your home’s location (local property tax rate) and the home’s value. And it’s important to remember that the amount you pay in property taxes can change yearly. To be safe, expect to pay $1 for every $1,000 of your home’s value every month in property taxes. So if your home is worth $300,000, you’ll likely pay around $300 a month in taxes, which equals about $3,600 a year.
Some states might require you to get an unbiased and official appraisal so your taxes can be estimated properly. The mortgage lender usually adds the appraisal cost to the list of closing costs.
Also, it’s important to know that your local government might require ongoing reappraisals every few years for tax purposes (depending on where you live), so be prepared for that. That’s why it helps to know the most profitable neighborhoods to invest in beforehand.
If you’re considering investing in pre-foreclosures, you can easily check to see if a house is in pre-foreclosure.
Insurance
The final “I” in PITI stands for Insurance. And there are two kinds of insurance you might have to get — homeowner’s insurance and mortgage insurance.
What’s the difference between homeowner’s insurance and mortgage insurance, you might be wondering?
Homeowner’s insurance is required to protect the lender’s interest in the home in the event of damage or theft. If you live in an area susceptible to natural disasters, such as floods or earthquakes, you might need even more coverage than someone who doesn’t. The annual premium payments for homeowner’s insurance are divided by 12 and added to your mortgage payment.
Mortgage insurance is to protect lenders from losses if you default on the loan and the home has to go into foreclosure.
That’s why most lenders require you to get private mortgage insurance (PMI). But on the upside, once you build up 20 percent in home equity, you don’t need mortgage insurance anymore, and your overall PITI payment will be lower (and more manageable).
Things that can affect your insurance premium include:
- The value of your home (how much it’s actually worth)
- How close you live to a police station or fire department
- Whether you live in a rural or urban area
- How many claims you make each year on average for other kinds of insurance
- Whether you have an attractive nuisance, which is something that might cause harm to your children or any children that visit your property, like a pool or trampoline.
So think about these factors when going through the various steps of purchasing your home.
How to Calculate Your PITI Payment
Now that we’ve answered the question, “What is PITI?” you need to learn how to calculate your PITI payment so there will be no surprises when it comes time to shop for a mortgage.
As stated earlier, determining your PITI payment can help you get approved for a mortgage much faster. Lenders want to know that you’ll be able to pay your mortgage based on your debt-to-income ratio and your PITI payment.
So, here’s how you calculate your PITI payment. Use an online tool like ProspectNow’s PITI payment calculator. That means you’ll need to know the following information:
- Loan term
- Home price
- Property taxes
- Down payment amount
- Homeowner’s insurance premium
- Mortgage interest rate
Plug these numbers into the calculator to help determine how much you’ll pay for your PITI payment.
Pro Tip: Some people don’t know that you can get a HELOC loan on an investment property, so consider that as an alternative funding option.
The Importance of PITI in Real Estate
A PITI payment holds a lot of significance in real estate, but why?
Lenders use the PITI payment amount when calculating your debt-to-income ratio. If you ignore the PITI payment, you might get preapproved for a lot less than you anticipated.
Don’t assume you can afford a home based on the principal and interest costs alone.
You’ll need to know your debt-to-income ratio because if the percentage is too low, you won’t qualify for a mortgage. Most lenders use the 28% rule as a first look when deciding if a loan is too risky.
If your PITI makes up more than 28% of your monthly budget, you might need to pay for more mortgage insurance before being approved for a loan.
Remember, though, that the PITI doesn’t cover all of your home buying costs. For example, you might have to pay for certain things out of pocket, such as repairs.
Some of the items included in the closing costs include:
- Title transfer costs
- Home inspections
- Appraisal
- Real estate attorney fees
Although these costs are included, some expenses aren’t. And you should be aware of those ahead of time so there are no surprises later down the line.
What’s NOT Included in PITI Payments
Some people make the mistake of thinking that certain things are included in PITI payments.
The following is NOT included in PITI payments:
- Condo or Homeowner’s Association (HOA) fees – These fees are separate from the PITI payment, and you’ll be responsible for paying them in addition to your PITI payment.
- Utilities – Lenders don’t consider how much you have to pay for gas, electricity, water, sewer, or trash. They also don’t take into account cable or internet bills.
- Maintenance – Maintenance costs are not part of PITI but may be required fees depending on where you purchase your home.
If you’re an investor or broker, these fees might be able to be passed on to the renter.
If you’re purchasing a home for yourself, you’ll need to factor these things into your overall budget to ensure you can afford them in addition to your mortgage. The last thing you want is to buy a home and not be able to pay all of your expenses.
Special Circumstances
It’s important to note that not all mortgage payments include taxes and insurance in some states. Some lenders don’t require that borrowers escrow these costs as part of their monthly mortgage payment.
In cases like these, you (the homeowner) would pay your insurance premium directly to the insurance company. Your property taxes would be paid directly to the tax assessor.
Determine whether you live in a state that requires taxes and insurance to be part of your mortgage payment.
Also, even if property taxes and insurance premiums aren’t escrowed, most lenders still consider these when calculating front-end and back-end ratios.
What is the Maximum PITI?
You might be wondering whether there’s a maximum amount you’ll have to pay for your PITI payment.
And the answer is that there is. The max on the PITI is 28%.
The maximum monthly payment for PITI is calculated by taking the lower of the following calculations:
- Monthly Income x 28% = monthly PITI
- Monthly Income x 36% – Other loan payments = monthly PITI
The maximum principal and interest payment is calculated by subtracting your monthly taxes and insurance from your monthly PITI payment. The formula uses your maximum PI payment to figure out how much of a mortgage you can qualify for.
Finding the Right Tools to Help You
Now when someone asks the question, “What is PITI?” you’ll be able to answer:
PITI (principal, interest, taxes, and insurance) payments are required of all homeowners that want to get a mortgage through a mortgage lender. PITI includes everything a homeowner typically has to pay when buying a home. For a smoother mortgage lending approval process, it helps to calculate your PITI payment beforehand, so lenders are more likely to approve you for a mortgage.
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