PITI stands for Principle, 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). In the event that you might lose your income or lack enough equity or other assets, your lender may require special considerations, such as two months of PITI.
So what exactly goes into PITI? A very high-level overview of its components include:
- Principal – This is the amount of your loan, so it is likely the cost of your home minus your down payment.
- Interest – Just like the majority of other loans, the interest is the amount the lender charges you for borrowing money.
- Taxes – Real estate tax rates vary significantly from area to area, so you should figure out just how much of your PITI goes to taxes.
- Insurance – Your lender may require homeowner’s insurance as part of your PITI.
Another requirement from your lender 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 pricey PMI payments.
Keep in mind that PITI may just account for just some of your monthly expenses when owning a home. Depending on where you live and how you are paying for your home, there may be additional costs. And the components that make up PITI are very broadly defined here; there is often more complexity that goes into each part of PITI.
PITI & Escrow
While many of us have heard of “escrow” when it comes to home buying (and other financial transactions), lesser known is lenders also consider PITI to be your “escrow account.” Your monthly PITI payments go into your escrow account. Your funds are disbursed to the lender for the interest and principal; property insurance (and for some, PMI) to the county for property taxes when they come due; and 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).
PITI & the 28% Rule
When it comes to calculating what you can afford regarding your PITI, a good rule of thumbs is that 28% of your gross monthly income is the maximum monthly cash outflow for costs associated with your house payments.
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
Example of Calculating the 28% Rule
Let’s say that you earn about $8,000 a month. You like a home that’s priced at $400,000 after you account for your down payment. You meet with a lender who tells you that you can get a 3.5% interest rate. Here’s how to calculate your PITI on a 30-year fixed rate loan.
- Your monthly mortgage principal and interest will amount to about $1,796 per month. Add on your property tax and insurance estimations.
- To calculate property taxes, you divide your home’s value by 1,000 and multiply that number by $1 to find your monthly payment. In this example, $400,000/1,000 is $400, a single month’s worth of property taxes.
- To calculate your interest payment, 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.
a. $400,000/1,000 = $400, $400 x $3.50 = $1,400, and $1,400/12 = $116.67, a month’s worth of homeowner’s insurance.
- Finally, add together all three numbers for your PITI estimation: $1,796 + $400 + $116.67 = $2,312.67, your PITI.
- Divide your PITI by your total monthly income to find your ratio.
If you earn $8,000 a month, your PITI would make up about 28% of your monthly budget. According to the 28% rule, congrats — buying this home could be a reasonable financial decision.
PITI is just one of the many financial considerations when making such a large financial commitment. A financial advisor can help you understand your PITI, as well as help determine how buying a home fits into your overall financial strategy.
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.