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

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

    It is important to understand how gross and net income impact the mortgage process.  Knowing the difference between your gross income, or your income before any deductions, and your net income or take home pay, 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 to pay taxes, social security medicare, retirement contributions and other deductions. 

    On the other hand, lender mortgage qualification guidelines are almost always based on borrower's monthly gross income as well as their 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
  • CalculatorUse our MONTHLY GROSS INCOME CALCULATOR to calculate your monthly gross income
  • 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.

  • CalculatorUse our Mortgage Qualification Calculator to determine what size mortgage you can afford based on your gross income
  • 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.

    • $6,250
    • $1,250
      Federal Tax
      border border
    • $220
      State Tax
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      Some states have
      no income tax
    • $265
      FICA Tax
      border
    • $90
      Medicare
      border
    • $125
      401k
      border
    • $65
      Heath Insurance
      border
    • $4,235

    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.

  • Rate Details*
    Loan Program:  
    Monthly Payment:  
    APR:  
    Rate:  
    Points  More Info:
    Points: Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
     
    Total Lender Fees:  
    Loan type:  
    Property Value:  
    Loan to Value:  
    Credit Rating:  
    Date Submitted:  
    Monthly Housing Payments
    P & I More Info
    Principal & Interest: A periodic payment, usually paid monthly, that includes the interest charges for the period plus an amount applied to the reduction of the principal balance.
    Mortgage Insurance More Info
    Mortgage Insurance: The monthly cost for a policy that protects the lender in case you’re unable to repay the full amount of the loan. It is typically required for loans that have a loan-to-value ratio between 80% to 100%.
    (Estimated)
    Property Tax More Info
    Property Tax: (Also called "Real Estate Tax.") Property taxes are government assessments on real estate property. With mortgage financing, the local, county or state tax assessment on real estate property is considered part of the monthly housing obligation and typically collected and set aside by the lender ...
    (Estimated)
    Homeowner Insurance More Info
    Homeowner Insurance: or also commonly called hazard insurance, is the type of property insurance that covers private homes. It is an insurance policy that combines various personal insurance protections, which can include losses occurring to one’s home, its contents, loss of its use, or loss of other personal possessions of the homeowner, as well as liability insurance for accidents that may happen at the home or at the hands of the homeowner within the policy territory.lender ...
    (Estimated)
    Homeowner Association Fee More Info
    Homeowner Association fee: (HOA) fees are funds that are collected from homeowners in a condominium complex to obtain the income needed to pay (typically) for master insurance, exterior and interior (as appropriate) maintenance, landscaping, water, sewer, and garbage costs.
    (If Any)
    Total Monthly Housing Payments
    Lender Fees
    Points More Info
    Points Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
    Origination Fee More Info
    Origination Charge: A loan origination charge is a fee charged by the lender for evaluating, processing, and closing the loan.
    Credit Report Fee More Info
    Credit Report Fee: Fee charged to obtain an applicant’s credit history prepared by one or all of the three major credit bureaus. Used by lender to determine the borrower’s creditworthiness.
    Tax Service Fee More Info
    Tax Service Fee: A fee charged by the lender to cover the cost of retaining a tax service agency. These agencies monitor the property tax payments on the property and report the results to the lender.
    Processing Fee More Info
    Processing Fee: A processing fee is a charge by the lender for clerical items associated with the loan. Examples of processing include loan set up, organization of loan conditions for underwriting, and preparing required disclosures for the borrower.
    Underwriting Fee More Info
    Underwriting Fee: A fee charged by the lender to verify information on the loan application, authenticate the property’s value, and perform a risk analysis on the overall loan package.
    Wire Transfer Fee More Info
    Wire Transfer Fee: In most cases lenders wire funds to escrow companies to fund a loan. Commercial banks that perform this function will charge the lender so the fee is generally passed on to the borrower.
    (If Any)
    FHA Upfront Premium More Info
    FHA Upfront Premium: A fee paid in cash at the close of escrow or more commonly it is financed into the loan. These premiums are pooled together by the FHA and are used to insure the risk of borrower default on FHA loans. FHA upfront premiums are prorated over a five year period, meaning should the homeowner refinance or sell during the first five years of the loan, they are entitled to a partial refund of the FHA upfront premium paid at loan inception.
    (If any)
    VA funding Fee (If any)
    Flood Fee
    Other Fees More Info

    Other fees could be either additional Administrative Fees that a lender charges or it could be a Flat Fee to cover all lender charges such as: (Origination Fees, Points, Underwriting and Processing Fees, Credit Reports and Tax Service Fees)

    The flat fee does not include prepaid items and third party costs such as appraisal fees, recording fees, prepaid interest, property & transfer taxes, homeowners insurance, borrower’s attorney’s fees, private mortgage insurance premiums (if applicable), survey costs, title insurance and related services.

    Total Lender Fees
    *Actual rates and other information may vary. Sponsored results shown only include participating lenders. The information you enter on this page will only be shared with lenders you choose to contact, either by calling the phone number or requesting a quote.
    Current Mortgage Rates as of December 11, 2018
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details.
  • Great Mortgage IdeaRelated FREEandCLEAR Resources
  • Sources

    Mortgage Income Requirements: https://www.fanniemae.com/content/guide/selling/b3/3.1/01.html

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. More about Harry

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