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Future homeowners and real estate investors looking for a deal often focus on the sale price when determining out how much house they can afford.
However, it is not the only expense you will need to consider to determine if they have enough money to purchase the home of their dream.
They will need to calculate the PITI amount to get a better picture of their buying power.
Here is everything you need to know about PITI before starting your home buying journey, whether that's to live in or as a real estate investment.
What is PITI?
The PITI acronym stands for:
Collectively, these 4 elements make up a monthly mortgage payment.
Principal and interest form the core of the PITI mortgage and are directly related to the loan itself.
However, lenders also require borrowers to include property taxes and homeowner insurance as part of the mortgage to protect the property, which is used as collateral for the loan.
Next, we’ll look at each element of PITI in depth.
The principle is the portion of your mortgage payment used to repay the loan before any interest is added.
It is typically the price of the house minus the down payment.
The interest element of PITI represents the amount the lending institution charges the borrower for loaning money.
It is calculated as a percentage of the total loan amount.
The interest rate varies depending on:
- the borrower’s credit score
- the type of loan they are applying for
- and more
Keep in mind that towards the beginning of the life of the loan, most of the monthly mortgage goes towards the I in PITI — interest.
Property taxes are calculated annually and determined by the municipality and fund public services, including:
- police forces
- road maintenance, etc.
Lenders typically require that they be paid as part of your mortgage payment.
The amount varies depending on the town and the assessed value of the building.
The tax share of PITI is held in an escrow account until taxes are due.
Although insurance is not required in every state, lenders often require borrowers to contract homeowner insurance to obtain a mortgage and therefore include it in the PITI.
Like property taxes, the insurance premium becomes part of your monthly payment and is held in escrow until the insurance premium is due.
Borrowers may also need to get premium mortgage insurance (PMI) if their down payment is lower than 20% of the house's purchase price, which will also add to the PITI.
Why PITI Matters
PITI is important to multiple parties in the home buying process. We’ll look at each one next.
Calculating the PITI is extremely important for home buyers since it gives borrowers a better picture of how much property they can realistically afford.
Real Estate Investors
For real estate investors, the cost of PITI is also an important indicator to verify the overall profitability of a property.
Ideally, a rental income should cover the totality — and more — of the PITI to be an attractive investment.
Lenders will also take into account the PITI amount compared to their income to determine whether or not to approve them for a loan.
Additionally, mortgage companies may also use the PITI payments to calculate the reserves required if needed.
How to Calculate Your PITI Payment
While you can easily find a PITI calculator online to determine how much house you can afford or if a property is a viable investment, it’s important to know how to calculate PITI on your own.
Start with the sale price of the property you are considering and subtract the down payment — this will give you the principal.
Next, check with your lender which interest rate they are offering depending on your credit score, the type of loan, etc.
Property taxes vary depending on the assessed value of the property and the municipality. You can find this information on public records (the tax card of the property), but those elements may be reevaluated regularly. Divide the number by 12 to calculate the monthly payment.
You may be able to get a free quote from an insurance company for the property you want to purchase, even if you do not end up using them. The amount of insurance you will need to pay depends on:
- the property
- its location
- if there are any risks attached to it (if it is located in a flood zone, for example)
- and more
Divide the number by 12 to obtain your monthly payment.
For example, let’s say you plan on purchasing a $250,000 property with a 20% down payment.
The lender offers a 4% interest rate for a 30-year fixed-rate mortgage.
Your monthly expenses, including principal and interest, will be approximately $954.
The property taxes for the house you are considering are $4000 per year, or $333 a month (the average cost of homeowners insurance in the United States is $1,312 per year or about $109 per month).
To calculate the PITI, add your monthly expenses.
In this case, the PITI = 954 + 333 + 109 = $1,396.
How Does Escrow Factor Into PITI?
While the principal and interest part of your PITI payments go to the lender, the monthly expenses you pay towards taxes and insurance will be held by your mortgagor into an escrow account.
The payments are released when it is time to pay your insurance premium and property taxes.
Since the property you are buying will be used as collateral for the loan, the lender wants to ensure that it is protected against liens and destruction.
Therefore, they collect the payments as a condition to the loan and include them in the PITI.
Some lenders do not hold the property taxes and insurance premiums into escrow; the borrower must pay them directly to their municipality or insurance company.
However, these expenses are still included in the PITI calculation.
What Is A Good PITI?
Mortgage lenders use your PITI payments against your income to evaluate your borrowing power.
As a rule of thumb, your PITI should be equivalent to 28% at most of your gross monthly income — your salary before taxes.
The lender may also use your debt-to-income ratio — including your PITI, but also other debt obligations such as credit card debt, student loans, auto loans, etc. — to decide whether to approve the loan or not. Most lenders prefer your debt-to-income ratio to be no higher than 36%.
If your PITI is higher than 28%, you may want to increase your down payment to reduce your principal amount and avoid paying for PMI.
You can also improve your credit score to obtain a better interest rate if possible.
PITI: the Bottom Line
Homeownership comes with many costs.
By calculating the PITI ahead of time, you will be able to focus your house hunting effort on properties you can comfortably afford and budget accordingly.
PITI is a priceless tool to better understand your financial obligations as a homeowner. It’s also an excellent calculator for real estate investors to evaluate the potential of a property.