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Monday, July 22, 2024

What is PITI?

What is PITI? 

Key takeaways

PITI stands for principal, interest, taxes and insurance. This combination is what makes up your annual homeownership expense.

06.14.2024

The journey of home-buying and homeownership includes plenty of jargon. One of the terms you’re likely to run into is PITI, an acronym for principal, interest, taxes, and insurance. PITI makes up your annual homeownership expense and helps determine how much house you can afford. 

If you’re in the market for a new house, PITI is one of the most important factors to consider, as it reflects the actual financial commitment associated with homeownership. And considering a home is one of the largest purchases most of us will ever make, it’s not one to go into without thoroughly running the numbers. 

What is PITI? 

PITI is an acronym describing the four key elements that are typically included in your monthly mortgage payment: principal, interest, taxes, and insurance. It’s one of the most important financial considerations related to your home-buying journey.  

PITI is used when you’re applying for a mortgage to calculate your debt-to-income ratio (DTI), meaning the portion of your income that goes toward debt. Your DTI, including your new housing expenses, must remain below a certain percentage for you to qualify for a loan. 

Let’s talk a bit more about the four key elements that make up PITI. 

Principal 

Your principal refers to the portion of your monthly payment that goes toward the principal of the loan. Your loan’s principal balance is the amount you actually borrowed. 

Suppose you buy a home with a purchase price of $300,000 and put down 10%, for a total loan amount of $270,000 — that’s your principal balance. That principal is amortized over the loan’s entire term, meaning you’ll pay a portion of it each month.  

The portion of your monthly payment that goes toward your loan principal changes each month based on your amortization schedule. It starts quite low at the beginning of your mortgage term and increases over time.  

For example, in the example we discussed of a loan with a $270,000 balance, if you had an interest rate of 4% and a 30-year loan term, only $389 of your very first payment would go toward the principal. By the halfway point of your loan, $706 of your payment would go toward the principal. Finally, by your last year of payments, almost the entire amount would go toward the principal. 

Interest 

Interest is the cost you pay your lender to borrow money. It’s the other most important component in your mortgage payment. Your loan’s interest rate can either be fixed or adjustable. A fixed interest rate, which is the most common, remains the same over the entire loan term. An adjustable interest rate can fluctuate based on the market. 

Your interest payments will follow the opposite trend from your principal. While your principal payments will increase over time, your interest payments will decrease. In the example we discussed above, $900 of your first monthly payment would go toward interest. By the time you’re halfway through your loan term, only $583 would. 

Read more: What is an interest rate? 

Taxes 

Property taxes are paid to your state and local government, usually on a quarterly or annual basis. But rather than paying your property taxes separately, many lenders include them in your loan payment and keep them in an escrow account until it’s time to pay your tax bill. Even if you choose to pay your own property tax bill and save on your own, your lender will still include taxes in your monthly payment for the purpose of qualifying for the mortgage. 

Unlike your monthly payment, your property taxes aren’t fixed. The amount you pay each year is based on your local property tax rate and your tax assessment, meaning what your local government feels your home is worth. 

Your property tax bill could change in a couple of different ways. First, your tax bill could increase or decrease if your state or local government votes to change property tax rates. Additionally, as your home is reassessed, your tax bill will change to reflect your home’s market value. While it’s possible for your property tax assessment to decrease, it’s more likely to go the opposite direction. The good news is that if you feel your property tax assessment is inaccurate, you can appeal it with your local government. 

Insurance 

The final component of PITI is your insurance. While homeowners insurance isn’t legally required like car insurance is, lenders do require that borrowers purchase homeowners’ insurance on their homes for as long as they have a mortgage. Like your property taxes, your homeowners insurance can be added to your monthly payment and go into an escrow account until the bill comes due. 

Another form of insurance that can be included in your monthly PITI is private mortgage insurance (PMI). If you put down less than 20% for a down payment on a conventional loan — even if you have good credit — you will have to pay PMI on your loan to protect your lender. Though PMI payments can be canceled once you gain 20% equity in your home, building up to 20% can mean years of PMI payments. 

PITI and your mortgage payment 

While your principal, interest, taxes, and insurance are all accounted for in PITI, only your principal and interest are actually a part of your mortgage. A portion of your mortgage payment goes toward principal, while the rest goes toward interest. 

Read more: Mortgage rates and the housing market 

Property taxes and insurance are a part of PITI and are considered a part of your monthly housing expenses, especially when it comes to qualifying for a loan. And in many cases, they may be included in the monthly bill you get from your mortgage lender. However, instead of going toward your loan, those portions of your payment go into an escrow account to be used to pay your tax and insurance bills. 

PITI and PMI 

PITI and PMI are two of the most common acronyms associated with home buying, and both are related to your mortgage payment. However, the two are entirely different things. 

PITI refers to the four components of your housing costs — principal, interest, taxes, and insurance. PMI, on the other hand, refers to the mortgage insurance you must pay if you put less than 20% down on a conventional loan. 

Complicating things even further, there’s another acronym that can refer to mortgage insurance: mortgage insurance premium (MIP). While PMI applies to conventional loans, MIP applies to FHA loans. PMI and MIP are both included in the “insurance” portion of your PITI if they’re required on your loan. 

Understanding PITI and the role of escrow accounts 

An escrow account is an account that’s held by your lender to manage your monthly payments for taxes and insurance. Unlike your loan payment, property taxes and homeowners insurance aren’t generally due monthly. Instead, they may be paid quarterly, semi-annually, or annually. 

Each month, when you pay your mortgage payment, your lender puts the portion of your payments for taxes and insurance into an escrow account. The money remains in that account until the bill comes due, at which point your lender will pay the bill from the escrow account. 

In some cases, the money saved in your escrow account may be too much or too little to cover your tax and insurance payments. In that case, you’ll either be issued a refund or will have to pay the difference. 

Escrow accounts are required for many first-time homeowners, and they come with several key benefits. It facilitates easier payment management of some of your housing-related expenses, such as property taxes and insurance. It also helps to provide financial stability. Rather than having to pay a large lump sum once per year — and possibly not having enough saved up — you’re able to spread those annual costs over 12 months to save a smaller amount at a time. 

How to calculate PITI 

If you’re applying for or have been approved for a mortgage, your lender will calculate your PITI based on your loan amount, interest rate, and repayment term, as well as your property taxes and insurance expenses. 

If you’re earlier in the process and want to get an idea of how much you’ll pay for PITI, you can use an online calculator to estimate it. Plenty of lenders, real estate websites, and personal finance sites offer these calculators to help borrowers estimate their future housing expenses. 

Of course, the numbers used in these calculators won’t be exact. They’ll often estimate an interest rate for you based on your self-disclosed credit profile. Additionally, your homeowners’ insurance and property tax amounts will be estimated based on your location. 

Even if you aren’t ready to buy a home now, calculating your potential PITI can be helpful because it allows you to estimate your future housing expenses. It allows you to get an idea of the price of the home you can afford based on your monthly budget. 

Determining affordable PITI 

When it comes to calculating what you can afford regarding your PITI, a good rule of thumb is that 28% of your gross income is the maximum monthly cash outflow for your housing costs. For example, if your gross monthly income is $7,500, then you can afford to pay about $2,100 for PITI. 

Another rule to consider is the 36%, which states that your housing payment (meaning PITI) and your other debt payments combined shouldn’t exceed 36% of your gross income. This is known as your back-end DTI. Depending on your financial circumstances and loan type, you may qualify for a loan with a back-end DTI of 50%, but the 36% threshold is ideal. 

Tip: You can track your cash flow using Empower’s free and secure financial tools. The tools enable you to categorize expenses and income to get an organized, visual snapshot of your financial picture. And when you sign up, you get access to the free Home Buying Guide with financial advisors’ insights into purchasing a house. 

While the 28% rule and 36% rule are helpful in estimating how much you can afford to spend on a home, they aren’t set in stone. They don’t necessarily accommodate people in especially high cost of living areas or those who have higher or lower monthly expenses than average. 

At the end of the day, you know your budget best. It’s important to get a firm grasp on your monthly cash flow to determine how much you can truly afford to spend each month on your housing expenses.  

Tip: You can track your cash flow using Empower’s free and secure financial tools. The tools enable you to categorize expenses and income to get an organized, visual snapshot of your financial picture. And when you sign up, you get access to the free Home Buying Guide with financial advisors’ insights into purchasing a house. 

If you need some additional help figuring out how much PITI you can afford, consider using a mortgage payment calculator or mortgage affordability calculator. These tools will ask for information about your personal finances and the home you plan to purchase and give you an idea of what you can comfortably afford. 

And remember, the amount you can comfortably afford is often lower than what a lender will approve. When you’re setting a budget for a house, ignore all the outside noise and base your decision on your budget rather than what anyone else says you can afford. 

Other PITI considerations 

Though PITI is a good starting point in calculating your monthly housing costs, it doesn’t account for everything. And when you’re in the market for a home, it’s important to budget for those other expenses to ensure you’ll be able to afford them. 

Here are a few other costs you may need to budget for: 

  1. HOA or condominium fees: If your neighborhood has a homeowners’ association (HOA) or condo owners’ association, then you’ll probably have HOA dues to pay either monthly or annually. HOA fees can range from a few hundred dollars per year to hundreds of dollars per month. 

  1. Utilities: Your monthly utility costs may include electricity, gas, water, trash collection, internet, and more. If you’re moving into a new home, especially if you’re moving from an apartment or a smaller home, you may see your utility bill increase or be on the hook for utilities previously covered by your landlord. 

  1. Repairs and maintenance: Paying for repairs and maintenance is an inevitable part of homeownership. Generally speaking, experts recommend setting aside 1% of your home’s value each year for maintenance and repairs. You may not use the entire amount, but it’s better to have that money set aside than to have a large expense come up and not have the money to cover it. 

Conclusion 

A home is a major purchase, and it’s important to have a firm grasp of your financial situation before taking that step. PITI is one of the most important factors that impact your housing affordability. It includes most of your housing payments and gives you an idea of the price of the house you can afford to buy. 

Your housing costs impact your ability to reach your other financial goals, including a comfortable retirement. It may be helpful to get a grasp of your retirement needs before buying a home so you can factor that information into your home purchase. 

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Courtney Burrell

Contributor

Courtney Burrell is a Senior Financial Professional at Empower. She coaches clients to build successful wealth building habits from mindset to successful saving and investing. 

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