PITI stands for Principal, Interest, Taxes, and Insurance. This is what makes up your monthly mortgage payment. Calculating your PITI number will help you determine how much house you can afford.
As the real estate market hits its springtime stride, many people are considering home purchases. What type of house should you buy? As you browse listings and search for your perfect property, you’re probably trying to settle on exactly how much you can afford.
This is perhaps the most important question to ask yourself when it comes to buying your home: How does this purchase fit into your overall finances?
Since buying a home is likely the largest purchase most of us will ever make, there are several aspects to consider when answering this question.
There are a lot of expenses involved in buying a home. The cost of the initial down payment isn’t the only expense you’ll need to calculate upfront. You also need to factor in all the expenses associated with purchasing, maintaining, and keeping the home. Your monthly mortgage, fees, taxes, insurance, home owner dues (i.e. HOA fees), and other associated costs are all line items on the home-buying bill.
All of these should factor into your overall budget for purchasing a home. For example, maybe you can afford a down payment on an $800,000 home, but the monthly payments will be too much of a strain. So what’s the first thing to consider when it comes to your monthly payments? PITI.
What is PITI?
PITI is an acronym describing the elements that make up your monthly mortgage, and it stands for the sum of monthly principal, interest, taxes, and insurance. PITI is one of the most important financial considerations related to your home-buying journey. This is usually calculated on a monthly basis. Your lender will compare it to your monthly gross income to see if you are a viable candidate for a mortgage loan (often called the debt-to-income ratio).
So what exactly goes into PITI? We’ll dive into the four different components below.
Principal refers to the portion of your monthly payment that goes toward the principal of your loan. Suppose you buy a home valued at $300,000 and put 10%, for a total loan amount of $270.000. Your total loan principal is $270,000, part of which you’ll pay off each month. The portion of your monthly payment that goes toward your loan principal changes each month based on your amortization schedule but will increase over time.
The chart below shows what portion of your monthly payment would go toward principal versus interest at different points in your mortgage if you had a $270,000 fixed-rate 30-year loan with a 4% interest rate.
|Your first payment||$389||$900|
|After 5 years||$474.97||$814.03|
|After 10 years||$579.93||$709.07|
|After 20 years||$864.58||$424.42|
The other part of your monthly payment is interest, which is the cost you pay to your lender for borrowing money. Your interest rate can either be fixed or adjustable, which you can decide when you borrow the home. If you have a fixed-rate mortgage, your rate will stay the same over the life of the loan.
In the early years, you’ll find that the majority of your loan payment goes toward interest, but that will change as you buy down more of the loan. To get an idea of how your interest payments change over time, you can look at the chart in the previous section.
Property taxes are paid to your state and local government, usually on an annual basis. But rather than you 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 the 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 purposes of qualifying for the mortgage.
Unlike your monthly mortgage 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. If your state votes to increase property taxes or your home value increases, your property tax bill will likely increase as well.
The final component of PITI is insurance. While homeowners insurance isn’t legally required like car insurance is, lenders 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 housing payment and go into an escrow account.
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 – even with good credit– then your lender may find your smaller down payment as a higher chance of default, thus requiring PMI. Though PMI payments can be canceled once you gain 20% equity in your home, building up to 20% can mean years of PMI payments.
What is PITI in Real Estate?
PITI — or principal, interest, taxes, and insurance — is a term most commonly used in real estate. But you’ll only have to worry about it if you use a loan to buy your home, which is true for most people. The reason this term only applies to real estate transactions and not other types of loans is simply that home buying and homeownership are more complicated (and more expensive). The taxes and insurance required for homeownership are considerably more than for any other type of purchase you might finance, which is why lenders include them in your monthly payment calculation.
What is PITI in a Mortgage?
PITI is used to calculate your mortgage payment, but not all four components of PITI are technically a part of your mortgage. Your mortgage payment is only made up of two components: principal and interest. Those are the components that go to your lender to pay off your loan.
The other components we mentioned, taxes and insurance, are a part of PITI, but they aren’t a part of your mortgage and don’t ultimately go to your lender. Instead, your lender collects them as a part of your monthly payment and puts them into an escrow account, which we’ll talk about more shortly. The money ultimately goes to either your local government or your homeowners insurance company.
PITI vs. PMI
The real estate and financial industries are filled with acronyms, and it’s easy to lose track of what each one means. And when it comes to home buying, two acronyms that are likely to cause confusion are PITI and PMI.
An easy way to keep these two terms straight is to remember that PMI — or private mortgage insurance — is a part of PITI, but PITI isn’t a part of PMI. If you have PMI on your mortgage it’s a part of the “I” at the end of PITI, since it’s a type of insurance.
PITI: Escrow and the 28% Rule
When it comes to home buying, an “escrow” account holds your monthly PITI payments, which are then disbursed to the lender for the interest and principal to the county for property taxes when they come due, and to your insurance carrier for your homeowner’s insurance.
For many first-time home owners, an escrow account is mandatory. And in many ways, it can be very useful. For instance, when the time comes for making the payments for real estate taxes, many find it easier to pay them monthly rather than face a large bill due at one time (or twice depending on your taxing jurisdiction).
How to Calculate PITI
When it comes to calculating what you can afford regarding your PITI, a good rule of thumb is that 28% of your gross monthly income is the maximum monthly cash outflow for costs associated with your house payments.
Tip: You can track your cash flow using Personal Capital’s free and secure financial tools. Categorize expenses and income to get an organized, visual snapshot of your financial picture. When you sign up, you get access to the free Home Buying Guide with financial advisors’ insights into purchasing a house.
Here’s one way to calculate the 28% rule.
Take the principal and interest of your monthly mortgage payment. Add 1/12 of your annual real estate taxes (aka one month of real estate taxes). Then add 1/12 of your annual homeowner’s insurance premium (aka one month of your annual homeowner’s insurance). Finally, add 1/12 of any annual association fees (such as one month of your annual HOA fees, if you’ll have them). Then divide this by your gross monthly income.
One variation of this is the 36% rule. This is calculated by taking your monthly PITI as calculated above, and then adding any homeowners-association dues or condo fees, credit cards, car loans, student loans, and any other personal loans. Then divide this by your gross monthly income.
So why the magic numbers of 28 and 36? This follows general guidelines on the amount of debt a person can take on while still maintaining enough cash for:
- Ongoing living expenses (food, car payments, clothing, entertainment, etc.)
- Retirement savings
How Much PITI Can You Afford?
We talked a bit above about the different rules of thumb you can use to determine what monthly payment you can afford. But despite having guidelines, the calculations are sometimes easier said than done. They also don’t necessarily accommodate people in especially high cost of living areas or those who have higher or lower monthly expenses than average.
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 you for. When you’re setting a budget for a house, ignore all the outside noise and base your decision based on your budget rather than what anyone else says you can afford.
Other PITI Considerations
As we’ve mentioned, PITI won’t necessarily make up all of your monthly housing expenses. And when you’re in the market for a home, it’s important to budget for those other expenses to ensure you’ll actually be able to afford.
Here are a few other costs you may need to budget for:
- HOA or condo fees: If your neighborhood or condo building has a homeowners association (HOA), then you probably have HOA dues you have to pay either monthly or annually. HOA fees can range from a couple hundred dollars per year to hundreds of dollars per month.
- Utilities: If you’re moving into a new home — especially if you’re moving from an apartment or smaller home — then there’s a good chance you’ll see your utility bill increase. You may also be on the hook for expenses your landlord covered, such as water and heat. According to EnergyStar.gov, the average family spends $2,060 per year on utilities, which comes to about $172 per month.
- Repairs and maintenance: Experts generally recommend setting aside 1% of your home’s value each year for maintenance and repairs. You may not use the entire amount each year, but you’ll want to save it for those years when you spend even more. So for a $300,000 home, you’d want to save $3,000 per year, or $250 per month.
Suggested Next Steps for You
- When considering a home purchase, it’s important to have a full sense of your financial picture. This helps determine what you can afford and how your home will fit into your monthly expenses. Sign up for Personal Capital’s free financial tools to get a 360-degree look at all your money, calculate your net worth, and track your cash flow and spending.
- Once you’ve signed up for the free tools, run the Retirement Planner tool to see how your home purchase will impact your long-term financial plan.
- Download our free Home Buying Guide for financial advisors’ insights into buying a house.