Are you wondering how to calculate PITI? Why do mortgage companies care about property taxes and homeowners insurance in the first place?
Good questions! Lenders care about taxes and homeowners insurance in part because they care about your debt-to-income (DTI) ratio. Your DTI is based on your total monthly payment, not just the debt payment for the mortgage.
You see, the payment for your mortgage debt is called your principal and interest payment, or “P & I payment.” It’s important to know how to calculate PITI. This is the bulk of your monthly payment, but it’s not all that’s required.
When calculating your affordability, lenders use the PITI payment. It stands for Principal, Interest, Taxes, and Insurance. Whenever you are determining your max purchase price, or a lender is qualifying you for a home loan, the PITI payment is the payment they’re going to focus on. This is why you should know how to calculate PITI.
Not everyone is responsible for these. Property taxes are determined at the county level, so depending on where you live, you may not have any property taxes (**ahem** entire state of South Dakota). Other places have really high property taxes to account for the lack of things like income tax. (Dallas, for instance, has a whopping 2.4% average annual property tax.)
Because it differs county to county, property tax information can be difficult to find online. Thankfully, our friends at RealtyTrac put together this great map that shows 2014 property tax rates by county.
When you are considering a particular home, take a look at its county. What is the estimated property tax rate?
Another quirk with property taxes is their due date varies from county to county. For example, in Los Angeles County, they’re due in November and February. In New York City, they’re due either quarterly or semiannually starting on July 1st. This can get confusing, and there are steep penalties if you forget a payment. Paying your taxes monthly may not be the most financially efficient thing to do, but it could smooth out your cash flow and save you from the headache.
For most first-time home buyers, their property tax payments will be tacked on to their monthly mortgage payment. Because of this, lenders include property taxes when calculating your affordability. But it’s still good to be aware of how your county collects property taxes so you can make sure your payments are properly applied.
The major point on homeowners insurance is that lenders require it in case something bad happens to your home (like a fire). They need to be sure that in the case of a major disaster, the house will be rebuilt.
In some cases, the lender may require additional types of insurance, like flood insurance. This is usually decided on a case-by-case basis. For instance, FEMA determines if your property is in a flood zone, which will drive the need for extra insurance.
- Pro-tip: FEMA has an interactive map that can help you determine if a property is in a flood zone.
But homeowners insurance doesn’t just protect the lender. It protects your investment in the home as well. Houses are a major asset, and a large investment. If an accident happens, you’ll be happy your home is covered.
Homeowners insurance is another cost that is highly variable depending on the property you purchase & where it is located. ValuePenguin has a great chart on the average cost of homeowners insurance by state.
Mortgage Escrow Account
You can elect to pay your property taxes and homeowners insurance yourself, or you can choose to have your mortgage servicer make this payment on your behalf.
If you choose to have your mortgage servicer handle the payments for you, they will hold the funds in an escrow account, also called an impound account. The servicer will keep your money in that account until it comes time to pay your taxes or insurance. The servicer also has the ability to collect reserve funds and hold them in your escrow account. The amount can vary, but they are generally used to cover any fluctuations in annual property taxes or homeowners insurance amounts.
The benefit to having the mortgage servicer make the payments is twofold. They collect the payment monthly, which helps reduce the chance of large payment spikes. It also streamlines your bill paying process: you cut one check to the servicer instead of paying three different parties.
It’s also worth noting that if your property is part of an HOA, your HOA dues are not generally included in your escrow account — you’ll continue to pay those separately.
Taxes & Insurance Payments Can Change
An important point to note is that both your property taxes and homeowners insurance payments can change annually. As the value of your home changes over time, your property tax amounts will adjust with it. The same goes with homeowners insurance, which adjusts based on a number of factors. If you know how to calculate PITI, you can simply adjust your number accordingly. If you’re curious about how homeowners insurance rates are set, esurance has a great article that breaks it down.
How to Calculate PITI: What’s Not Included in PITI Payments
There are two things that are not included in your monthly payment that you should know about.
1. Home Maintenance – Home maintenance costs are not included in your monthly payment, but will need to be budgeted for. These will vary every year and will depend on how old your home is, but a good rule of thumb is to budget 1-2% of your home value per year in maintenance costs.
2. Utilities – Your payment also doesn’t include any utility payments. Power, water, gas, internet, and cable/satellite can add up quickly. If you’ve paid these as a renter, you’ll have a good idea what they cost. Otherwise, ask around so you can budget accordingly.
- Pro-tip: Cable or satellite TV can be expensive. Cutting the cord and using streaming services can be a great way to cut down on your utility bills.
To learn more about DTI check out Mortgage Basics: Amortization, Debt-to-Income Rate and Closing Costs or chat with a licensed Loan Specialist. To see what your loan options look like, apply easily online now.