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

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

Edited by Michael Jensen, Mortgage and Finance Guru

Updated November 6, 2020

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.

• Use ourMortgage Qualification Calculatorto determine what size mortgage you can afford based on your gross income

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.

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.

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.

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.

Sources

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