When considering buying a home and trying to determine just how much home they can afford, some would-be homebuyers make the mistake of using a simple online mortgage calculator. A few may even just look at the principal cost of a home and do a bit of division to estimate a monthly mortgage payment.
But when lenders do the math on the mortgage payment a borrower can cover, the figure they consider is called “PITI.”
PITI stands for:
Principal: The original amount of the mortgage loan.
Interest: The amount of interest you pay on the principal loan. The longer the term and the higher the interest rate, the more interest you pay.
Taxes: Property taxes vary by county, city, and sometimes from one location to the next within a city. A good rule of thumb is to use 1.25% of the value of the home as an estimate of the annual tax amount. For example, a home value of $500,000 x 1.25% (as a factor that is 0.0125%) gives an annual rate of $6,250. Divide that number by 12 (number of months in a year) to get $521, and you have your estimated property tax payment.
Insurance: As a homeowner, you need to maintain property insurance to cover the loss of your home. Lenders require that the home be insured for loss. Insurance premiums can vary by company so it’s best to shop around for coverage. To estimate the payment for this insurance, it’s best to use a rule of 0.36% (0.0036 as a factor) of the loan amount. For example, if you are borrowing $450,000, you would multiply by 0.0036 to get the annual figure (in this case, $1,620) and divide by 12 for the monthly payment ($135).
These are the main payments lenders consider when qualifying for a home loan. There are other housing and mortgage-related payments that are considered if they are applicable.
Homeowners Association Dues: If you purchase in a community that has a homeowners association group, oftentimes they charge a monthly fee for services, utilities and physical maintenance. The monthly fee is considered in the PITI calculation.
Mortgage Insurance: Don’t confuse this with homeowners Insurance. This is an insurance policy that your lender will require if you put less than 20% down on your home when you use conventional financing. This policy is often referred to as PMI. Many factors are considered when determining the amount of coverage (cost to you), but a good estimate to use for this payment is 1% of your loan amount.
The full amount of a monthly PITI and all housing-related payments can be quite a bit higher than homeowners expect!
So, why is all this math important? Lenders use these figures to best determine your ability to be a successful homeowner. Lenders use a front-end ratio based on all the anticipated housing expenses (PITI plus any other housing related payments like association dues or private mortgage insurance) as a percentage of your gross monthly income. Generally speaking, this ratio shouldn’t exceed 28%, but other factors can be considered for this ratio to be higher.
Lenders also use a back-end ratio to consider your potential success as a homeowner. Using all of your debt, including car payments, credit card payments, student loans AND your anticipated housing expenses, lenders will want to see a ratio of around 38% (as divided by your gross monthly income). Other factors can be considered which will allow for a slightly higher back-end ratio.
As you can see, there’s a lot to calculating your home loan payment and the qualifications for a home loan purchase. Call the experts at PMG Home Loans for a confidential review. We will help you find the right loan with the most affordable payment, making your dreams of homeownership a reality.