The Four Components of PITI: Principal, Interest, Taxes, and Insurance

The Elements of a Buyer's Monthly Mortgage Payment

Define PITI
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PITI is an acronym that stands for "principal, interest, taxes, and insurance." Those four things make up many, but not all, borrowers' monthly mortgage payment.

All borrowers with a mortgage have to pony up for property taxes and insurance, although not everybody does that through their mortgage payment. Owners who buy a home in a planned unit development or a townhouse/condo complex also pay a homeowner association (HOA) fee, which may or may not include insurance for their individual unit.

The Principal

Principal is the part of the mortgage payment that applies directly to the amount of money you borrowed from your lender. Some would say it's the most important portion of the payment because it reduces the unpaid balance of your mortgage. Note that paying interest does not reduce the principal portion of your mortgage.

The Interest

Mortgage interest is the main way the lender makes a profit on your loan. (The lender also receives money at closing from the borrower in the form of discount points, which are paid to get a better rate on a mortgage.)

The way amortization, or the paying down of a mortgage, is structured for a 30-year loan such that the largest portion of a monthly payment is initially paid to interest, with only a small fraction of the payment applying to principal. As time goes on and you get closer to the end of the amortization period, a larger portion of the monthly payment is paid to the principal, with a smaller amount applying toward interest.

The Monthly Principal and Interest Payment

As an example, let's say you borrowed $200,000 at 5 percent interest over 30 years. The first payment of principal and interest (P&I) would be $1,073.64, with the interest accounting for $833.33 and the principal accounting for $240.31.

Determining the amount you will be paying every month in P&I on a fixed-rate mortgage (one for which interest rate stays the same throughout the course of the loan) is easily done using a monthly payment calculator.

The Discount Factor

If you like a math challenge, however, you can calculate it yourself with the help of two formulas:

P = A / D
D = {[(1 + i)^n] - 1} / [i(1 + i)^n]

In the first formula, P is the monthly payment, and A is the loan amount. In both formulas, D is the discount factor. In the second formula, i is the periodic interest rate (the annual rate divided by 12, the number of payments in a year) and n is the number of periodic payments, or the number of payments per year times the number of years. The caret before each n indicates it is an exponent, meaning you'll be raising what precedes it to the nth power.

First calculate that i is 0.00416667, or 0.05 divided by 12. Then calculate that n is 360, because you're multiplying 12 (the number of payments per year) times 30 (the number of years for the mortgage). Plugging those numbers into the second formula gives you 186.281717.

Divide the loan amount, $200,000, by 186.281717, and you arrive at the monthly payment of $1,073.64.

To determine the component parts of that monthly total, first multiply $200,000 times 0.05, which equals $10,000. That's the amount of interest that must be paid in the first year. Divide by 12 and you arrive at the monthly interest payment of $833.33. Subtract $833.33 from the principal and interest total of $1,073.64, and the result is $240.31 of principal.

Taxes

Every county has its own taxation system. The rate of taxation can change from year to year, and sometimes properties are reassessed upon resale, so you should not count on the previous homeowner's tax payments remaining the same for you. Check with your county assessor's office for information on your property taxes.

The timing of your first tax payment after closing depends on how much the lender withholds when setting up the tax account. You can assume anywhere from two to six months will be collected in advance as part of your closing costs.

Insurance

If your house is included in a homeowner's association, the HOA generally maintains a blanket insurance policy for the complex, which is paid from your HOA dues. However, you may still want to maintain an insurance policy on the contents and interior of your unit, and your lender might require it.

If you are buying a single-family home, you will need to obtain an individual homeowner's insurance policy. Do not wait to shop around until the last minute, especially if you're buying an older home, which some companies are unwilling to insure.

You will need to pay upfront for the first year of insurance coverage at closing, but you may arrange with your lender to pay for subsequent years of coverage through your mortgage payments.