Napkin Math for Basic Property Evaluations Part 1
When looking for a new investment property, you do not want to spend too much time making initial calculations on each property. You want a quick way to calculate your loan amount and payment. Luckily, there is a quick, back of a napkin calculation that can help you estimate your monthly cost for each potential investment property. Start with the general rule of thumb that says you get a loan for 75% of the appraised property value. Your monthly loan payment is then a function of four parts: principal, interest, tax, and insurance. You’ll also see the acronym PITI (Principal, Interest, Tax, and Insurance) used to describe this expense. Here is a little more information about each of the components in PITI.
1. PRINCIPAL
Principal is the portion of your loan payment that goes towards paying down your loan balance. The principal portion of PITI changes every month. It is the smallest in the first month and gets a little larger with each subsequent month. This is why your outstanding loan balance does not seem to go down much in the first few years.
2. INTEREST
Interest is the portion of your loan payment that goes to pay the monthly interest due to the lender. The amount of interest that you owe each month is a function of the current outstanding balance of your loan. So, the interest component of PITI is highest in the first month and decreases with each subsequent month.
3. TAXES
In PITI, the taxes refer to property taxes. These are taxes that you pay to the country government where the property is located. In some cases, you may also be responsible for paying property taxes to the city government. The property taxes are a function of the appraised value of the property. The amount of taxes paid on each property are part of the public record, so it should not be too hard to find this the annual tax due on the property. Search the internet for the county tax assessor (for example, XX County, State Tax Assessor). Include the state in the search since another state may have the same county name. Once you’ve found the correct website, you should be able to locate tax assessments on the property for the previous years. Remember that you will need to divide this value by 12 to get a monthly expense estimate.
4. INSURANCE
The cost of insurance can vary widely by property and provider. Finding a ballpark estimate of annual insurance expenses, however, should become easier once you have gotten a few basic quotes from an insurance provider. Remember that you are only trying to get a rough, back of the napkin cost estimate right now. The basic quotes you get should be enough to show you how the cost may change depending on the size, age, or number of bedrooms and bathrooms.
Principal and interest make up your monthly loan payment, and there are many mortgage apps that will help you quickly crunch the numbers to find this payment based on the loan amount, term, and interest rate. Some of these also have the option to enter general tax and insurance numbers or those that you specifically provide. PITI is important because it is considered the base for your decision-making process. In the next part, we will discuss how to compare PITI with the real or expected property income as well as some common mistakes that investors make.