Unfamiliar jargon and terminology that's used in real estate can make entering the housing industry more daunting than it needs to be. One of the most important acronyms you'll come across in your home-buying journey is PITI, which stands for Principal, Interest, Taxes, and Insurance. Here are the four components that make up a mortgage payment and what each one involves.

P - Principal

The principal is the amount of the loan itself. To keep the math simple, take a $100,000 mortgage: the principal is $100,000. Over time the amount you pay will be more than the initial principle. Your lender will provide an amortization schedule showing how much principal is paid-off each month after your monthly payment is applied to other items.

I - Interest

The lender earns their money based on interest paid on the loan or principle. Sometimes you can pay extra interest points to provide their profits early so they will sell you a loan that has a lower interest and lower monthly payment.. When you make your mortgage payments, a portion of that payment goes towards interest. It's important to know that in the early years of your loan, more of your payments will go towards interest than principal. However, as time goes on, the ratio gradually shifts, with more of your payments going towards paying down the principal. 

T- Taxes

Real estate taxes or property taxes are assessed by the local county government and are used to fund public services voted on by the community, such as schools, police forces, and fire departments. These taxes are calculated annually, and you may get to choose if you pay them directly or pay them in your monthly mortgage payments. The lender will collect these payments and hold them in escrow until the taxes are due. 

I - Insurance

There are two types of insurance that may be included in your mortgage payments. Property insurance, which protects your home and its contents from fire, theft, and other disasters. The second type of insurance is required if the down payment is often below 20%, in which case private mortgage insurance (PMI)  is mandatory. Depending on the size of your down payment you may also get to choose if you pay your property insurance directly to your insurance company or if it must be paid within your monthly mortgage payments. 

What PITI Represents

Well, because PITI represents the total monthly mortgage payment, it helps both the buyer and the lender determine the affordability of an individual mortgage. A lender will look at an applicant's PITI to determine if they represent a good risk for a home loan. Buyers can use PITI to decide if they can afford a particular property.

In general, mortgage lenders prefer the PITI to be equal to or less than 28% of a borrower's gross monthly income. Consider this a calculation guideline the lender uses as a guideline on deciding what loan limits one qualifies for as a borrower.. In addition to this, PITI is also included in calculating a borrower's back-end ratio, which is the sum total of their monthly obligations against their gross income.

Conclusion

Be wise in planning your next loan decision and learn what expenses make up that monthly payment you will be paying after closing on your mortgage and when deciding on what mortgage options to select looking for a new property. If you’re not sure on what makes up the mortgage payment or how to lower it, ask. You can change the outcome by offering to pay property taxes and insurance outside of the escrowed mortgage as well. Think of PITI before you begin the home-buying process as another set of terms to negotiate with your lender as you would when negotiating on a purchase contract and ask your lender to explain the pros and cons of the various options for your situation.

So remember, a home's total monthly mortgage payments are determined using the abbreviation PITI (Principle, Interest, Taxes and Insurance.) Both buyers and lenders should be aware of the entire payment when calculating mortgage payments. The PITI is ideally below 28% of the borrower's total monthly income, according to lenders. 

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