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The Difference Between Gross and Net Income When You Apply for a Mortgage
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The Difference Between Gross and Net Income When You Apply for a Mortgage

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

It is important to understand how gross and net income impact the mortgage process.  First off it is important to define what gross income and net income are.  Gross income is your income before deductions for taxes, social security, medicare and any health insurance or retirement account contributions you make.  Net income, also known as your take home pay, is your income after all of these deductions.

In short, gross income is the figure at the top of your pay stub while net income is the actual amount you receive in your pay check. Knowing the difference between gross and net income helps you understand what size mortgage you qualify for and how lenders evaluate you when you apply for a loan.

Most borrowers think about how much of their net income they should spend on their monthly payment when determining what size mortgage they can afford. From the borrower's standpoint, thinking about mortgage affordability in terms of gross income makes less sense because a significant portion of your earnings goes toward deductions.

On the other hand, lender mortgage qualification guidelines are almost always based on your monthly gross income as well as your debt expenses. From the lender's perspective, it is easier to determine what size loan you can afford by looking at your gross income before adjusting for any deductions. This is mostly because deductions and how net income is calculated varies based on numerous factors while the definition of gross income is the same for all applicants.

Please note that some borrowers have items such as 401(k) contributions and health insurance costs deducted from from their gross income on a pre-tax basis and the gross taxable income reported on their W-2 tax form reflects these deductions.  For example, if you earn $80,000 in annual gross income and make $10,000 in 401(k) and health insurance contributions using pre-tax dollars, the gross taxable income reported on your W-2 is $70,000.  In this case, the lender uses the higher gross income figure of $80,0000  to determine what size mortgage you can afford.  The reason most mortgage lenders use the higher gross income figure is because many of the pre-tax deductions you take are elections that you could stop making if you need money to pay your mortgage.

The table below outlines the difference between gross and net income explains the role of both in the mortgage process.

Understanding Gross and Net Income for a Mortgage
Gross Income
  • Monthly gross income is the amount of money you make before any deductions
  • Your paycheck states a gross income for the period worked as well as all of the deduction that are subtracted from the gross income
Net Income
  • Net income is what most of us refer to as take-home pay
  • Net income is the money we actually get to keep and spend on things like mortgages
  • The difference between gross income and net income are the various deductions that are subtracted from our paychecks. Some of the most common deductions include federal and state income taxes, Social Security tax (also known as FICA), Medicare tax, as wells as health insurance and 401K contributions
Which Figure is More Important: Gross or Net Income?
  • Both. The reason we cover both gross and net income is because they are both used in the mortgage process – just by different parties
  • Most borrowers think about their net income when determining their ability to make a mortgage payment
  • Lenders, on the other hand, look at a borrower’s gross income to determine the mortgage someone can afford
Calculating Your Monthly Income
  • If you are paid on a monthly basis, then it is pretty straightforward to determine your monthly gross and net income. Many people, however, are paid weekly, bi-weekly or bi-monthly, in which case it may be a bit tricky to calculate your monthly income figures

To verify your gross income, lenders usually request your pay stubs for the two months prior to submitting your mortgage application. The pay stubs include your gross income before any deductions and lenders use this information to verify the income figure you provided on your mortgage application. You can also provide a letter from your employer with your annual gross income to the lender as a supporting document.  Lenders also request that you provide your W-2s for the prior two years to confirm your past gross income.

Using your application and supporting documents, lenders determine the loan amount you qualify for based on your monthly gross income, debt payments, credit score and other inputs. If you are self-employed, have fluctuations in earnings or earn a significant portion of your income from bonuses or commissions, lenders typically use your average monthly gross income over the prior two years, as opposed to your income for the most recent month.

It may seem odd that lenders use your higher gross income figure instead of your net income as you actually end up not receiving a significant chunk of your gross earnings. But lenders apply a debt-to-income ratio that limits how much of your gross income you can spending on your mortgage and other monthly debt payments and this ratio factors in your income deductions.

Gross and Net Income Example

Below is an example that shows the various deductions that are subtracted from gross income to calculate net income.  The individual in this example makes $6,250 in monthly gross income.  After subtracting federal and state taxes, social security (FICA), medicare, a 401k contribution and health insurance cost, the individual in this example makes $4,235 in monthly net income, or take-home pay.

Please note that deductions vary by individual and location due to differences in federal and state tax brackets and rates. For example, some states do not charge income taxes. Additionally, you have discretion over the size of deductions you take for items such as retirement account contributions and health insurance, if applicable. You can review your pay stub to understand what deductions are subtracted from your gross income to arrive at your net income.

  • Federal Tax
  • State TaxSome states have
    no income tax
  • FICA Tax
  • Medicare
  • 401k
  • Heath Insurance
Gross Income Net Income

The table below shows mortgage rates and closing fees for top lenders in your area.  We recommend that you contact multiple lenders to learn more about their mortgage qualification process.  Shopping lenders and comparing loan proposals also enables you to find the mortgage and program that are right for you.

%
Current Mortgage Rates in Mountain View, California as of December 2, 2020
FREEandCLEAR Exlusive Lender
Low Rates
No Bait & Switch
Online App
2.497% APR Rate: 2.375%
30 Yr Fixed30 Yr Fixed
Points: 1.0
Rate Lock: 60 days
NMLS: 357085  LICENSE: CA 00532825
Terms & Conditions
Ask about no closing cost options
APR
2.497%
Rate
2.375%
Points
1.0
Rate Lock
60 days
NMLS: 357085
LICENSE: CA 00532825

Terms & Conditions
Ask about no closing cost options
Loan terms assume conforming mortgage amount, 80% LTV ratio and minimum borrower credit score of 740. Purchases and rate and term refinances only. $150,000 minimum mortgage amount. Borrower is responsible for $1,055 lender fee. Loan terms are subject to change without notice.
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  • Payment
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View All Lenders

%

Data provided by Brown Bag Marketing, Inc. Payments do not include amounts for taxes and insurance premiums. Read through our lender table disclaimer for more on rates and product details.

Related FREEandCLEAR Resources

Sources

"B3-3.1-01, General Income Information."  Selling Guide: Fannie Mae Single Family.  Fannie Mae, August 7 2019.  Web.

About the author
Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR.  Harry is a licensed mortgage professional (NMLS #236752). More about Harry

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