How PITI Affects Your Mortgage and Investment Decisions

Key Takeaways

• To help ensure loan repayment, many mortgage lenders estimate PITI before extending a loan.

• PITI is a valuable tool in real estate investing because it can reveal whether the rental property, income-wise, could be a worthwhile investment.

• Together, the four PITI components of principal, interest, taxes, and insurance comprise a monthly mortgage payment.

Many investors rely on an instrument known as PITI to tell them whether a property in which they are interested would likely make money, and mortgage lenders commonly estimate PITI before extending a loan. But just what is this tool? Below is an understanding of PITA: principal, interest, taxes, and insurance.

What is a PITI?

PITI is an acronym for principal, interest, taxes, and insurance. The calculation is used by investors, homeowners, and lenders to help determine whether a house is affordable or whether a property will be profitable. Mortgage lenders size up the borrower’s PITI payments against their income to gauge their buying power.

For home buyers, it has been long recommended that a borrower’s PITI should be equal to 28%, at the most, to their growth monthly income. A higher PITI could necessitate a bigger down payment to lower their principal amount and get around having to buy private mortgage insurance (PMI), discussed more later. An improved credit score may also garner a better interest rate.

What Does PITI Stand For?

Note that together, the four PITI components of principal, interest, taxes, and insurance essentially comprise a monthly mortgage payment. Still, to protect the property, which is used as loan collateral, lenders also require borrowers to include homeowner insurance and property taxes as part of the mortgage.

Here is how the components break out individually for investors and homeowners:

Principal

This is the part of the mortgage payment that is used for loan repayment before the addition of interest. It is usually the property’s price less the down payment.

For example, if one purchases a home valued at $250,000 with a down payment of 20% ($50,000), their principal amount would be $200,000. 

Some lenders may also factor a borrower’s debt-to-income ratio – total sum of monthly debt payments divided by total income — into their lending decision. Most lenders prefer to see a ratio of no higher than 36%. 

Interest

This is the amount the bank or other lending institution charges the borrower for the loan and is calculated as a percentage of the loan amount. For example, if one’s principal loan is $200,000 and the interest rate is 4%, they must pay $8,000 in interest the first year of the mortgage. 

The interest rate one is charged hinges on the borrower’s credit history, loan type, and other factors. 

Note that early in the life of the loan, most of the monthly mortgage goes toward interest. As the loan matures, the amount of interest to be paid drops because the principal shrinks. Say one pays $8,000 in interest on the initial year of their $200,000 mortgage. When that principal falls to $50,000, the borrower will pay just $2,000 annually. This underscores the importance of selecting a property within one’s price range, as it is easy to get behind on payments if the interest cannot be paid off and the principal is not decreasing.

Taxes

Property taxes are frequently overlooked as a cost of ownership. Lenders usually require that property tax payments be folded into the mortgage payment. Such taxes are calculated each year and established by the municipality. Property taxes are used to fund police departments, libraries, park upkeep, schools, road maintenance, and the like.

The tax amount will depend on the city in which the property is located as well as the property’s assessed value. In general, one can expect to pay $1 monthly in property taxes for each $1,0000 of the property’s value. If one’s home is valued at $250,000, for example, monthly property tax payments will be around $250 monthly, which comes out to $3,000 annually.

In most states the borrower must get a third-party home appraisal so that taxes can be accurately assessed. Fees for such an appraisal are usually included in closing costs.  

Note that the PITI tax share is held in escrow until taxes are due.

Insurance

While not every state requires homeowner insurance, lenders frequently require borrowers to maintain a certain level of such insurance before extending a loan. Such insurance should cover one’s property in the case of fire, break-in, or lightning storm that damages the property.

As with property taxes, it is hard to know precisely how much one can expect to have to pay in homeowner’s insurance, since each insurance company employs its own formula for rate calculation. As a general rule, however, one can expect to make annual payments of roughly $3.50 for every $1,000 of the home’s value. 

The insurance premium becomes part of the monthly payment, and like property taxes, is held in escrow until due.

If a down payment is less than 20% of the property’s purchase price, borrowers might also need to obtain a PMI policy, which will also contribute to the PITI. 

How to Calculate Your PITI 

Here are steps for calculating one’s PITI on a 30-year fixed loan:

1. Gauge principal and interest. Monthly mortgage principal and interest payments will come out to roughly $1,432.25. Tack on one’s property tax and homeowner’s insurance estimates.
2. Estimate property taxes. Calculate estimated property taxes by dividing the property’s value by 1,000, then multiply that figure by $1 to get the monthly payment. Here, $3000,000/1,000 is $300, or a month’s property taxes. It may be helpful to check one’s state government website for the availability of a property tax estimator. This will provide a realistic figure for the amount of property taxes one might have to pay after purchasing the new property.
3. Discover what the insurance payment will be. Calculating the insurance payment calls for dividing the value of one’s home by 1,000, multiplying that by $3.50 then dividing the result by 12. That will provide a year’s worth of monthly insurance payment. $300,000/1,000 = $300, $300 X $3.50 = $1,050, and $1,050/12=$87.50, which is a month’s worth of insurance.

To get the PITI estimate, add all three numbers together: $1,432.25 + $300 + $87.50 = $1,819.75. One’s ratio may be calculated by dividing the PITI by their total monthly income. If monthly earnings total $7,000, say, the PITI would comprise some 26% of the monthly budget, which could be manageable. 

Why is PITI So Important to Consider?

For one, PITI is important to consider for homebuyers because they must think about their monthly expenses before taking out a mortgage loan. By figuring out one’s PITI ahead of time, the borrower will be able to center their shopping efforts on properties they can afford, and budget appropriately.

PITI is also important for lenders to know so that they can trust the borrower for loan repayment. Thus, in making a loan approval determination, lenders will compare PITI to the borrower’s income.

Further, mortgage companies may also utilize PITI payments to determine what size reserves will be required, should they be needed. For real estate investors, PITI is a valuable calculator for helping to determine a property’s potential.

PITI: Other Considerations

There are other considerations when it comes to PITI, including other expenses that should be calculated when determining how much one can afford to spend in housing costs. Such expenses can include homeowner’s association (HOA) fees and even maintenance costs.

Then there is the alluded to private mortgage insurance, which is frequently required for conventional mortgage loan borrowers whose down payment on their home purchase is relatively low. Such insurance protects the lender should payments stop on the loan. Insurance costs are typically between 0.1% to 2% of the annual loan amount.

Understanding PITI: Benefits It Can Provide in Real Estate Investing

For real estate investors, the PITI cost is a key indicator of a property’s likely profitability. For a rental property to be an attractive investment, its income should cover the PITI, at least. So, PITI is a valuable tool in real estate investing.

While no investment is risk-free, real estate in general remains popular as what is called an alternative investment – holdings in assets other than stocks and bonds – as investors seek to generate income in ways unrelated to an inherently volatile stock market.

Take Yieldstreet’s offerings, for example. To date, the investment platform has funded some $4B in alternative investments, with a 9.8% IRR. Its real estate offerings include a real estate investment trust (REIT), which are kind of like mutual funds. REITs allow investors to take positions in real estate, but without the physical property. They are enterprises that own commercial properties such as hotels, retail spaces, office buildings, and apartments.

Yieldstreet’s real estate investment trust, called a Growth & Income REIT fund, makes equity investments in commercial real estate nationwide in key markets and property types including self-storage, multi-family industrial, hospitality, and retail. Investment minimums on the platform are as low as $10,000.

Real estate can also be a smart way to diversify one’s investment portfolio, which can reduce overall risk and protect against inflation. 

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

Lenders, brokers, and homebuyers can benefit from PITI, as can real estate investors. who can use PITI costs to tell them whether a potential investment in a property will likely be worthwhile. Real estate is generally a popular way to invest outside the stock market, while serving to diversify holdings.