If you’ve been looking to purchase a new home, you’ve probably done a lot of research. You’ve looked at home prices and neighborhoods. You’ve run comps to see how much recent homes in the same range sold for. You’ve put together your upfront down payment and budgeted for closing costs. And finally, you’ve started looking into the preapproval process for a loan.
When talking to a lender about a mortgage, you’ll frequently come across the term PITI—principal, interest, taxes, and insurance—which is only used when referring to real estate loans. This is because the taxes and insurance on homeownership are typically a lot higher than for most other types of purchases; therefore, lenders include them in the monthly mortgage payment calculation. Let’s talk about PITI and how it can affect your mortgage.
What is PITI?
PITI—principal, interest, taxes, and insurance—is an acronym that describes the components that make up your monthly mortgage payment. While PITI calculates the monthly mortgage payment, only two of the four elements—the principal and interest—go towards paying off your loan. Your lender collects the remaining two—taxes and insurance—and puts them into an escrow account to be sent to either your local government or your homeowner’s insurance company.
When purchasing a home, the PITI is one of the most important numbers you’ll need to keep in mind because knowing the total PITI will allow you to see whether the home—and the monthly payment—is affordable. This is especially important for first-time home buyers to ensure they’re not borrowing money they can’t pay back.
In addition to looking at your credit score, your lender will calculate your debt-to-income ratio (DTI) by looking at your gross monthly income to see if you qualify for the mortgage loan. They will also calculate the following:
- Front-end ratio: The front-end ratio simply looks at your gross monthly income and compares it to the PITI to calculate what percentage of your income the PITI will be to determine affordability.
- Back-end ratio: The back-end ratio looks at the PITI and your other monthly debt obligations. Typically, banks prefer a borrower’s back-end ratio to be 36% or lower, though some lenders will go higher.
Mortgage lenders like seeing a PITI or housing expense equal to or less than 28% of a borrower’s gross monthly income.
The components of the PITI
The PITI has four primary components:
- Principal
- Interest
- Taxes
- Insurance
Let’s discuss each of these individually.
Principal
The principal is the original loan amount, that is, the amount of money you’ve borrowed for your home purchase. Let’s say you’ve bought a house for $125,000 with $25,000 as the initial down payment. That means you’re borrowing $100,000 from the bank or other mortgage lender. That $100,000 is your principal.
The principal, of course, is not the only thing you’ll be paying off. There’s also the interest on that amount.
However, the P in the PITI calculation is the principal, and it’s important to note that while your mortgage payment will remain the same over time, this number changes significantly over the course of the loan.
Initially, loans are structured to keep the amount of principal repaid low. This means that in the early years of your mortgage, you’ll mostly be paying interest. In later years, the principle will constitute a larger portion of your PITI.
Interest
The first “I” in PITI stands for interest, which is the payment you make to the lender as part of the cost of taking out the loan. How much the interest amount ends up being in your PITI payment will depend on the interest rate, the term of the loan, and whether you have a fixed-rate mortgage or an adjustable-rate mortgage.
The interest payment calculation is based on the loan balance, so you’ll see that the amount you’re paying in interest is higher at the beginning of the loan term and then decreases as that principal balance is paid down over the life of the loan. Towards the end of your loan term, you’ll primarily be paying off the principal.
As mentioned earlier, while the principal and interest amounts will change from month to month, your monthly mortgage payment will remain the same. This is due to mortgage amortization, which refers to the process of paying off your mortgage loan with regular monthly payments so that your bill remains the same each month, even though the principal amount and interest are changing. Your bank or mortgage lender will give you an amortization schedule with your closing paperwork.
Taxes
When you buy a property, you’re expected to pay taxes. Yet, buyers often overlook taxes when calculating purchase expenses and determining real estate’s affordability.
Your property taxes help support the local community, paying for things such as roads, schools, community services, police and fire departments, and public transport. Tax rates can differ widely from state to state.
Property taxes are paid to the state and local government once or twice annually. While you can choose to pay these directly, many lenders include them in your loan payment by dividing your annual bill by 12 and collecting it monthly. The taxes you pay as part of your mortgage payment are then held in an escrow account, and the lender is required by law to pay the property tax bill when it comes due.
Insurance
Homeowners insurance, unlike other forms of insurance, such as car insurance, is not required by law in most US states. Still, many mortgage lenders will require an insurance policy as a condition for your loan. This is to cover your property in the event of a fire, a natural disaster, or a break-in.
How much you’ll pay in insurance will come down to several factors, including your home’s value, type of mortgage, whether you live in a rural or urban area, and whether you have anything valuable in the property. For example, if you live in a condominium, you’ll pay a Homeowners Association (HOA) fee instead of individual insurance.
Like with real estate taxes, insurance premiums can be paid each month and held in escrow by your mortgage provider.
Two types of insurance can apply to your mortgage payment:
- Homeowners insurance: This is the insurance we’ve discussed above, which protects you from incidents of damage and theft. You may need to purchase additional coverage if your property is in a disaster-prone area.
- Mortgage insurance: On a conventional mortgage, if your down payment is less than 20% of the home’s purchase price, you’ll need to pay Private Mortgage Insurance or PMI. This is to protect your lender from losses in case you default on your payments and in the event of a foreclosure. The mortgage insurance premiums are added to your PITI number.
Loans backed by the Federal Housing Administration (FHA) require FHA mortgage insurance, no matter the amount of your down payment.
(Read more about PMI and FHA mortgage insurance in this article.)
How to calculate your PITI payment
When purchasing a home, it’s a good idea to calculate your PITI payment to determine how much house you can afford. While the mortgage lender will do these calculations as well, sometimes it’s helpful to know your numbers early in the process, especially if you’ve been looking at properties with a real estate agent and need to determine what your monthly bill might look like.
A good rule of thumb when calculating your PITI is that it should be no more than 28% of your gross monthly income since those are the numbers your lender will judge your application by.
To start, you’ll want to know your mortgage payment’s principal and interest portions. Add 1/12 of your annual real estate taxes and 1/12 of your homeowner’s insurance premium. You’ll want to divide this number by your gross monthly income to arrive at the percentage.
You can also use online tools such as LendingTree’s home loan and mortgage calculator to determine your PITI.
The bottom line
PITI, or principal, interest, taxes, and insurance, make up the components of a typical mortgage payment. When buying a house, you must understand what these numbers mean, how they will affect your ability to purchase a property, and the monthly outgoings you’ll have once you’ve signed the contract.
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