Why Lenders Use Gross Monthly Income vs. Take-Home Pay

Written by Posted On Monday, 26 October 2020 05:00

It might seem curious to some why mortgage companies use gross monthly income when determining affordability instead of ‘take-home’ pay. After all, it’s the take-home pay that consumers use to pay bills including the mortgage but also other monthly expenses as well. Credit card debt and auto loans are paid each month but so are things like mobile phone bills, food, gas and other expenses. But there are a few good reasons why lenders use the gross amount instead of net pay.

First, it’s a universal application. Everyone is qualified using the very same guidelines. Lender A uses gross monthly income and so does Lender B and Lender C. When calculating debt-to-income ratios to evaluate affordability, the debt ratio guidelines use gross monthly income. There are a few loans that do take into consideration monthly expenses and ‘residual’ income, but most every other program uses gross monthly income.

Second, lenders aren’t aware of individual deductions. One person might have a monthly deduction for health care while someone else would have their health care paid for by their employee as a company benefit. Someone else might have a cable bill while another party ‘cut the cord’ a long time ago. Child support payments, student loans and other monthly expenses can vary from one person to the next. It’s almost impossible for those in the secondary markets to individually adjust a single loan program based upon individual choices. Fannie Mae and Freddie Mac for example have debt ratio guidelines but these are also based upon gross monthly income. Net income is flexible whereas gross monthly income is not.

When employers report income each year to the IRS, the amount reported is gross income, not net. When consumers are asked to document their loan application as it relates to income, the last two years of W2 forms are needed along with recent paycheck stubs. The gross amounts on the paycheck stubs should align with the presented W2 forms. Trying to parse net income from these documents is literally impossible. 

Another reason is how consumers view their own income. Sure, they will know what the amount will be on each individual paycheck, but when asked how much they make each month or even each year, they know the gross amount automatically. “I make $100,000 per year” is the gross amount, for example. Consumers who try and figure out their annual pay using net income would be difficult to discern. It can be done, but it’s the gross income they remember. When employers advertise for a new employee and the subject of pay comes up, it’s the gross amount. There’s no way an employer would know the financial situation of an individual’s deductions and expenses to explain how much they pay each month.

If you’re thinking of buying your first home and want to know what you might qualify for, there’s no shortage of online prequalification calculators to get started. Sometimes though, consumers can enter their take-home pay instead of gross monthly income not realizing they’re short-changing themselves when they do so. Lenders, believe it or not, want to keep it simple. They use gross income, not net.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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