Principal, interest, taxes, insurance: what's actually in a mortgage payment (PITI)

Ask most people what their mortgage payment covers and they'll say "the loan." In practice, a typical monthly mortgage payment usually bundles together four separate things, principal, interest, taxes, and insurance, commonly abbreviated PITI. A calculator that only computes the first two can leave out a meaningful part of what you'll actually pay every month.

The four pieces

Principal is the portion of your payment that reduces the amount you actually owe on the loan. Interest is the cost of borrowing that money, charged on your remaining balance. Together, principal and interest (often written "P&I") are what a basic loan-payment formula calculates, and they're fixed for the life of a standard fixed-rate mortgage.

Taxes means property taxes: the amount your local government charges based on your home's assessed value. Property tax bills are typically issued annually or semi-annually, not monthly, but many mortgage arrangements collect a monthly share of that bill along with the mortgage payment so the full amount is on hand when it's due.

Insurance covers two possible things: homeowners insurance, which protects the property itself and is generally required by the lender for as long as the loan is outstanding, and, if it applies to your loan, mortgage insurance, an additional cost some lenders require when a down payment is below a certain threshold, separate from the coverage that protects the home. Like property taxes, homeowners insurance premiums are often billed annually but collected monthly as part of the mortgage payment.

Where escrow comes in

The mechanism that makes monthly collection of an annual tax or insurance bill possible is an escrow account. Each month, in addition to principal and interest, the loan servicer collects roughly one-twelfth of your estimated annual property tax and insurance costs and holds it in this account. When the tax bill or insurance premium actually comes due, the servicer pays it directly out of escrow, so you never have to set aside a lump sum yourself or risk missing a due date. Because the estimate is based on projected costs, escrow accounts are typically reviewed once a year and adjusted up or down if actual tax or insurance costs came in different from what was collected.

Why a P&I-only number can be misleading

Consider a $300,000 mortgage where the principal and interest payment works out to roughly $1,799 a month. If property taxes run about $300 a month and homeowners insurance runs about $100 a month, escrow adds another $400 to the payment, bringing the actual monthly cost to roughly $2,199, about 22% higher than the P&I figure alone:

Principal & interest:      $1,799
Property taxes (escrow):     $300
Homeowners insurance:         $100
                            -------
Total monthly payment:     $2,199

Property tax rates and insurance premiums vary widely by location and property, so there's no single number that applies everywhere; the point is simply that a calculator or quote showing principal and interest alone is describing part of the payment, not the whole thing. When comparing what you can actually afford, or comparing one property to another, PITI (or an itemized P&I-plus-taxes-and-insurance figure) is the number that reflects what actually leaves your account each month.