What Is PITI, and Why Is It So Important for Home Buyers to Know?

Don’t get caught off guard by the extra financial obligations of homeownership.

For many homeowners, some of the costs of ownership come as a surprise. While you're probably aware of the fact you'll have a new home loan to pay for, your expenses go beyond just the amount you need to pay off your mortgage.

You don't want to be one of the many who is caught off guard by the extra financial obligations you're taking on when you own your own place, so it can be helpful to understand four of these key costs up front. Fortunately, there's a simple acronym that's used to help you remember the biggest costs that you'll have as a new homeowner. It's "PITI," and stands for "principal, interest, taxes, and insurance."

Understanding PITI is actually important for two key reasons. Here's what they are.

1. PITI helps you estimate your total monthly payment

The biggest reason you should know what PITI means is because these four big expenses will likely make up the monthly payment you must make after buying a home.

• Principal: Principal is, over time, likely going to be one of the biggest homeownership costs. It refers to the total loan balance on your mortgage when you borrow. For example, if you borrow $200,000, you must pay off $200,000 in mortgage principal over the life of your loan.
• Interest: Interest is the cost of borrowing, or the finance charges imposed. It's expressed as a percentage of principal. For example, if your loan is at a 4% interest rate, you'll owe interest equaling 4% of your outstanding balance each year. Interest costs will be huge at the start of your loan, but will decline over time as your principal balance goes down and you pay financing charges on a smaller amount.
• Taxes: Property taxes are paid to your local government, but chances are good your mortgage lender will collect them. If that's the case, the lender determines your annual property tax cost, divides that amount by 12 months, and adds that amount to your monthly payment every month. The money is then kept in a special escrow account. When your taxes come due, the lender pays them out of your escrow account. This is done to ensure you aren't hit with a big annual tax bill you can't pay.
• Insurance: Insurance is homeowner's insurance, which is paid to your insurance company. But, like property taxes, your lender will probably collect the money necessary to cover your annual insurance bill each month, put it in escrow, and use it to pay the premium when it is due.

Together, these four costs add up to the amount of your monthly housing payment. You need to make sure you can afford to pay the total due each month, taking PITI into account.

2. It determines how much you'll be allowed to borrow

Since lenders want to make sure you can afford your loan, they'll also consider PITI when deciding how much to lend to you. Many lenders want your total monthly housing costs to be below 28% of your income.

If you're considering taking out a loan, you'll ideally want to keep your monthly payment -- including PITI -- below this threshold. This will help ensure you have the best choice of lenders, qualify for the lowest rate, and have monthly housing payments that are as affordable as possible.