Buying a new home is thrilling, but it can also be very confusing for new home buyers. Lots of acronyms are common in the mortgage industry, and those who are buying a home for the first time can have trouble understanding everything that is being discussed. PITI is one of these acronyms and it, along with escrow, is crucial to understand before the home is purchased. Read through the information here to learn more about what PITI is, how it works, and how escrow will work after getting a mortgage and closing on a home.
What is PITI?
PITI stands for principal, interest, taxes, and insurance. It is what makes up the mortgage payment each month. The mortgage payment is more than just principal and interest, so it is important to know what is included, why it’s included, and how to determine the actual mortgage payment once everything is included.
- Principal – This is the loan itself and a part of every mortgage payment will go towards paying off the principal, though the percentage is typically lower at the beginning of the loan. It does increase as the mortgage payments are made.
- Interest – This is the interest on the loan and can vary based on the going rate for mortgages at the time, the amount of credit the buyer has, and whether they can use any points to lower the interest rate. The percentage of the payment going toward interest starts higher than the principal at first but lowers with time.
- Taxes – State and local taxes need to be paid on homes. Many mortgages will include the taxes in the mortgage payment, so they aren’t due all at once for the homeowner. Instead, the homeowner pays a portion of the expected taxes with their mortgage and the lender pays the taxes when they are due.
- Insurance – Most mortgage lenders require insurance in case anything happens to the home while it has a mortgage. Many of them will bundle the insurance with the mortgage, so part of the mortgage payment will go towards the insurance. Like with taxes, this money goes into an escrow account and is paid out when due.
What is Escrow?
An escrow account is simply an account used to hold the money until it is needed. After a mortgage is obtained, the escrow account will be created and part of the mortgage payment will go into the escrow account each month. The amount can vary based on the expected taxes and insurance costs. However, these are predicted amounts, so they may not be perfect.
Some years, the homeowner may receive a refund at the end of the year because they’ve overpaid into the escrow account. Other years, they may be required to pay extra because they didn’t pay in enough through the year to cover taxes and insurance. Most of the time, if insurance or taxes increase, the lender will increase the amount due each month to ensure there are sufficient funds in the escrow to cover everything.
How Escrow and PITI Work Together
The homeowner pays a set mortgage payment each month, the whole PITI. This is the only amount they need to worry about, so they don’t have to worry about paying for the mortgage, plus the interest, plus the insurance, plus the taxes. They simply pay one set amount to the lender. This can vary from year to year if taxes or insurance increase, but should generally stay relatively stable. Once the lender receives the payment, they split it into the necessary components.
Part of the mortgage payment is used to pay the lender back for the loan. The rest is placed into the escrow account where it is held until needed. The lender handles all of this and does provide updated information to the homeowner, typically yearly, on the amount needed for the escrow if the current payments are not sufficient or the amount of a refund expected if the payments were higher than the amount needed for taxes and insurance.
Pros of Using Escrow
Escrow is required by many lenders, and there are reasons to take advantage of it. With escrow, it’s possible to ensure taxes and insurance are paid without having large bills due at the end of the year or having to pay a monthly amount on top of the mortgage payment. Everything is split into monthly payments and bundled together. Some lenders do offer discounts for choosing to use escrow, so that could be an advantage as well. Plus, the responsibility for the payments will go to the lender, so there’s just less for the homeowner to worry about – they don’t have to think about taxes or insurance and the bills will still be paid. Less to worry about, especially in the beginning, could be incredibly helpful for new homeowners.
Cons of Using Escrow
While escrow accounts are generally a good idea, there are some reasons why homeowners may not want to pay into escrow and may choose to avoid PITI payments. With escrow, it is possible to overpay and receive a refund at the end of the year. While the refund is usually great for homeowners, it does mean that there’s more money tied up in escrow than there needs to be, so the homeowner doesn’t have access to that money until the end of the year. The other downside is that it may be necessary to make a few monthly payments for taxes upfront depending on when the mortgage is started during the year.
For a new home buyer, understanding the various acronyms and terms used by the lender is crucial as it allows them to make a better decision for their money. PITI is standard with mortgage companies, as is using an escrow account, but there may be times when this isn’t desired. If you’re planning on buying a home, use the information here to start learning more about your mortgage payment and what you should expect once you close on the home.