What Is PITI & the 28% Rule?
Now is the time to purchase a home with record low-interest rates. If you are considering making the leap into homeownership here are a few things you need consider. First how much can you afford? There are many items to factor into your overall budget for purchasing a home. You will need to think about all the expenses it will take to purchase, maintain and keep your home. Examples of these items are your monthly mortgage, fees, taxes, insurance, homeowner dues and other associated costs. The biggest chunk of the budget will be the monthly payment. The first thing you need to look at when it comes to your monthly payments is the PITI.
What is PITI?
PITI stands for the sum of monthly principal, interest, taxes and insurance. The PITI is what makes up your total monthly mortgage payment. First, there is the principle which is the amount of your loan, then comes the interest which is the amount the lender charges you for borrowing money, next is the property tax (this rate varies from area to area) and last is the insurance which is the cost of your homeowner’s insurance.
There might be other additional costs to the PITI. If you are not able to put the standard 20% down for a down payment then you will have another added expense called PMI. PMI is Private Mortgage Insurance. Depending on where you live, there might be additional costs built-in.
PITI & Escrow
An interesting fact is that lenders refer to PITI as your escrow account. How it works is that your monthly PITI goes into your escrow account and then is distributed to the interest, principal, property insurances, PMI if applicable and property taxes.
An escrow account is especially helpful for first-time homebuyers. Instead of paying a lump sum for your property taxes at the end of the year, you can pay monthly into your escrow account saving up for your annual bill.
PITI & The 28% Rule
To calculate what you can afford when it comes to your PITI you should use the 28% rule. “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.”
How is the 28% calculated? You take the principal and interest of your monthly mortgage payment and add the following. One-twelfth of your annual real estate taxes (i.e., one month of real estate taxes), one-twelfth of your annual homeowner’s insurance premium (i.e., one month of your annual homeowner’s insurance) and one-twelfth of any annual association fees (i.e., one month of your annual HOA fees). Take the total and divide it by your gross monthly income and this will give your 28%.
This is the rule of thumb when it comes to figuring out how much you can afford and still have enough for other living expenses and savings.
If you are in the market, a financial advisor can assist you with understanding PITI and other financial considerations. It is important to have a full financial picture to help determine how much home you can afford.
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