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Whether you are a first-time home buyer or you have been around the block a few times, understanding your financial situation is an essential part of buying a property.
Before you get wrapped up in beating out other offers and buying a house, you need to ask yourself – How much can I really afford?
The answer to this question lies with the PITI, aka, your monthly mortgage payment. In this article, we’ll look at what makes up PITI and how understanding it can help you as a borrower.
What Does PITI Stand For?
PITI stands for principal, interest, taxes, and insurance. These are the four factors that make up a monthly mortgage payment.
Understanding PITI can help you calculate how much house you can afford and guide your decision-making.
The principal will make up the most significant portion of your monthly mortgage payment. This is the amount that you owe on the loan without any interest. It is the baseline of the loan you borrow.
The interest is a percentage of the principal loan amount you pay as a fee for borrowing money.
This interest rate is disclosed and agreed upon before you close on your home and will be part of your monthly mortgage payment.
Property taxes are determined at the county level and will be based on the home’s value. In many cases, you will “escrow” your taxes with your mortgage lender.
This means a portion of your total monthly payment will go towards an escrow account. Your lender then accesses the funds from your escrow account to pay your taxes when they are due.
Another expense you can escrow is your homeowner’s insurance. Your homeowner’s insurance will cover any damage to the property, such as a fire, a storm, a robbery, and more.
This amount will be determined by various factors, including the home’s value, proximity to fire and police departments, high liability items, and your claims on other types of insurance. To get the best deal, shop around and ask for quotes.
>> More: How to Apply for a Mortgage
How to Calculate PITI
Figuring out how to calculate your PITI is the first step to seeing what you can afford.
You’ll need to know the type of loan you will be receiving, typically a 15-year fixed-rate or 30 year fixed-rate, your interest rate, and how much you will be borrowing.
How much you borrow will be the sales price of the property minus your down payment.
Calculating PITI Example
Now that you know what we need to calculate PITI let’s see it in action.
Step one: Calculate principal and interest
Let’s say your loan will be a $250,000 loan with a 30-year fixed rate of 3%. Your monthly principal and interest will come out to be $1,054.00.
Step two: Calculate taxes
To calculate property taxes, you take the home’s value and divide it by $1,000. Then, multiply that number by $1 to find the monthly payment.
With our example – $250,000/1,000 = 250. Each month you’ll pay $250 towards taxes.
Step three: Calculate homeowners insurance
For home insurance payments, 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.
$250,000/ $1,000= $250
$250 x $3.50 = $875
$875/12 = $72.00
Step four: Total your PITI
The fourth and final step to calculate your total PITI will be to add these principal, interest, taxes, and insurance together.
$1,054.00 + $250 + $72.00 = $1376 total monthly mortgage payment
What Is the Difference Between PITI and Escrow?
You may hear your online mortgage lenderrefer to your PITI and monthly mortgage payment as your ‘escrow.’ Each month when you pay your mortgage payment, the funds go into your escrow account.
The principal and interest stay with your lender while the insurance and taxes are disbursed to the insurance company and county, respectively. Your insurance will most likely be paid once a year, while taxes will be paid semi-annually or annually.
For many first-time homebuyers, an escrow account is required. Even if it is not, it can be very convenient for you to pay towards these items monthly rather than making larger lump sum payments once they are due.
>> More: What Is Private Mortgage Insurance?
How PITI Affects Your Mortgage
The PITI is what makes up your total monthly mortgage payment. It will give you an idea of what you can afford and alert you to any adjustments you need to make.
You may need to reconsider the price range of homes you’re looking for or how much you will borrow.
It will also help your lender decide what type of mortgage loan and loan terms you will qualify for.
They’ll use the PITI calculation to determine whether or not you’re a safe borrower.
>> More: How Are Mortgage Rates Determined?
PITI and the 28% Rule
Before giving you the final approval for your loan, your lender will compare your PITI against your income to determine whether you’ll be able to afford it.
The PITI should be no more than 28% of your gross monthly income to pass this test in good standing. The lower the percentage, the better your chances.
If your PITI is more than 28% of your gross monthly income, you may need to adjust how much you’re looking to borrow.
Let’s say you make $6,000 in gross monthly income. Using our previous PITI calculation, your PITI will make up 23%.
$1376 / $6,000 = 0.23
Does PITI Include Homeowners Insurance?
Yes, homeowners insurance is included in your PITI. If you are purchasing a home, your lender will require some form of insurance.
This serves to protect their financial interest in the property, and it’s just the sensical thing to do to protect your most valuable asset.
Are HOA Fees Included in PITI?
Homeowner association fees are not included in PITI. These dues are separate from what you are borrowing from the lender that you will need to pay for separately.
The HOA dues and fees should be disclosed to you by the seller before closing. Be sure to consider these dues in your monthly budget.
Bottom Line: What Is PITI?
PITI is what makes up your monthly mortgage payment. Understanding where these items come from and how much you can expect to pay for each will help you calculate how much house you can afford.
As a general rule, your PITI should not exceed 28% of your gross monthly income. It is an excellent tool for creating a smart financial strategy as you approach homeownership.