As interested home buyers enter the real estate market in search of the perfect property, it’s crucial that they develop an awareness of their own financial situation. Many buyers are so concerned with the asking prices of homes they don’t realize that homeownership comes with a number of additional expenses. Before you set your sights on a home, make sure you can afford all of the costs by learning what PITI is and how it impacts your monthly mortgage payments.
What Is PITI?
PITI is an acronym that stands for principal, interest, taxes and insurance – the four major elements that make up mortgage payments. While the principal and interest tend to be buyers’ primary focus, it’s vital that you understand all components of your monthly mortgage payments. Often, buyers underestimate the true costs by failing to account for property taxes and homeowners insurance. These expenses can nearly double your monthly homeownership expenses, which is why you must budget for them before settling on your new home.
Common Homeownership Expenses
Looking at the purchasing price of a home can give you some insight into the expenses involved. However, you can get deeper insight by examining the individual costs that comprise your monthly mortgage payment.
A mortgage is the loan a lender gives you to purchase a home. When you receive the funds, the home is used as collateral, and you are charged a fee for the privilege of borrowing money. Over the course of the loan, you must pay back the principal – the amount of money you borrowed to purchase the property – and interest – the fee charged by the lender based on the amount borrowed.
Although the down payment is not included in PITI, it directly impacts your monthly payments. A down payment is the amount of money you pay upfront to purchase a home. This one-time cost is a percentage of the purchase price, typically 5% – 20%. While many buyers try to avoid large down payments, putting more down can actually save you money in the long run. The higher your down payment, the less you’ll need to borrow, meaning both your principal and the amount of interest you pay on it will be lower.
Property taxes constitute the third part of PITI. The amount of taxes you pay on your home is based on the appraised value of the property. Although it’s included in your mortgage payments, this money is held in escrow and sent to the government to pay for local services, improvements and public schools.
Your PITI also includes homeowners insurance, which protects your home in the event of damage or loss. Since your home is used as collateral for your loan, the insurance is also used as a precautionary measure to safeguard your lender’s investment. Much like property taxes, the money required to pay your insurance is held in an escrow account and transferred to the insurance company when the payments come due.
How PITI Impacts Your Mortgage
Your PITI directly impacts your mortgage because it makes up your payments. However, you can and should use PITI to work backward. By examining your PITI, both you and your lender can determine the extent to which you are a good candidate for homeownership.
Knowing what your approximate annual taxes and insurance will be can help you determine how much you’ll actually owe on a monthly basis. All you need to do is divide the total costs by 12. For example, if you learn that taxes are approximately $3,700 annually, you can divide that by 12 months to find how much you need to budget for taxes each month. Once you’ve discovered that about $308 of your monthly payment will be for taxes, you can do the same calculations for your insurance. Then, simply add the monthly taxes and insurance expenses to your principal and interest to arrive at the approximate amount you’ll be spending each month. Keep in mind that if you live in an area that has high tax rates, your property taxes can really alter how much house you can comfortably afford.
It Helps Determine How Much House You Can Afford
By looking at your current monthly expenses, you can calculate the maximum amount you’re able to spend on PITI, that is the amount you can realistically afford to spend on mortgage payments each month. With knowledge of your monthly budget, you can determine the highest price you can comfortably spend on a new home. If you begin your home search after you’ve calculated your PITI, you’ll be able to maintain a pragmatic mindset and quickly rule out all of the homes outside of your price point.
It Helps Mortgage Lenders Decide Whether To Loan To You
In addition to demonstrating how much you can afford to spend on a home, your PITI can also show mortgage lenders how risky it is to lend to you. Calculating PITI is one way that lenders determine whether you qualify for a loan. Once they’ve calculated it, they’ll compare your PITI to your income to ensure that you’re not taking on more debt than you can afford to pay back.
PITI And The 28% Rule
As mentioned, mortgage lenders will measure your PITI against your income to determine whether you qualify for a loan. To be considered a good candidate, your PITI should be no higher than 28% of your gross monthly income, that is your salary before taxes. The lower the percentage, the more willing lenders will be to offer you a loan. If your PITI is too high, you can improve it by increasing your income. If that’s not a possibility, you can make a higher down payment or find a home that costs less.
While you can calculate your PITI by hand, Quicken Loans® has online tools that can simplify the process. Our Mortgage Calculator will compute your potential monthly mortgage payments and allow you to see the breakdown of your PITI. However, using this tool will require you to already have a sense of your home price, down payment and interest rate, as well as your potential annual taxes and insurance.
If you’re just starting the process and don’t have that information available, you can choose to use our Home Affordability Calculator instead. This tool will use information about your income, debts, savings, credit score and ZIP code to establish the maximum amount you can afford to pay for a home.
Since your monthly mortgage payments will consist of your principal, interest, tax and insurance costs, it’s advantageous to calculate your PITI at the outset of your home buying journey. Instead of wasting time seeing homes you can’t afford, knowing your PITI will enable you to focus your search on the homes that are actually within your price range. If you would like to learn more about your options, create a Rocket Mortgage® account or speak to a home loan expert by calling (800) 251-9080.