gross income Archives - Stated-Income

Knowing how much mortgage you can afford is one of the most important steps you can take before buying a home. Getting in over your head can cause buyer’s remorse and worse yet, financial troubles. Before you let that happen to you, learn how much of your monthly income you should spend on your mortgage.

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Understanding Gross and Net Income

First, you should know that lenders look at your gross income when qualifying you for a mortgage. This is not your take home pay. In other words, this isn’t the money you see in your bank account. It’s the money you make before taxes and other deductions. If you are being realistic with yourself, you should base how much mortgage you can afford on your net income. This may mean that you take a mortgage that is less than a lender approves you for and that’s okay.

Using the Conventional Guidelines

We prefer to use the conventional guidelines to determine how much mortgage you can afford. While conventional guidelines are a bit more conservative than any other loan program, they help you stay in control of your finances.

According to conventional loan guidelines, your housing payment shouldn’t exceed more than 28% of your gross monthly income. Here’s an example.

Let’s say you make $75,000 per year. Your gross monthly income is $6,250. If you take 28% of that amount, you’d have a mortgage payment equal to $1,750. If your take home pay is 85% of your gross pay, the mortgage payment would actually be 33% of your take home pay. This is why we prefer the conventional loan guidelines as it keeps your mortgage payment as a small portion of your income.

The Total Mortgage Payment

It’s important to understand what goes into the total mortgage payment. When a lender tells you how much mortgage you can afford, the payment will include:

Principal
Interest
Real estate taxes
Homeowner’s insurance
Mortgage insurance (if applicable)

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The $1,750 we discussed above doesn’t mean all principal and interest. You would have to take out 1/12th of the annual real estate taxes, homeowner’s insurance, and mortgage insurance, if necessary. What is left will cover the principal and interest.

Your Total Debt Ratio

Lenders also look at your total debt ratio. This is the total of all debts compared to your gross monthly income. You don’t have to include debts like utilities, school tuition, or insurance payments. It’s only the payments that are included on your credit report. The most common include:

Credit card minimum payments
Installment loans
Car loans
Student loans

A good rule of thumb is to keep your total debt ratio at 40% of your gross monthly income. If you use conventional or government-backed mortgage programs, your absolute maximum debt ratio allowed will be 43% according to the new mortgage guidelines.

If you don’t have a lot of ‘other debts,’ you may have a little more leeway in your mortgage payment. Lenders might be a little more flexible, allowing your housing ratio to hit 30% or so. This will vary by lender, though.

Only you know how much money you are comfortable spending on your mortgage. Don’t take the allowed amount from a lender at face value. Do your homework and figure out what payment will comfortably fit within your budget. Remember, your mortgage is something you may have for the next 30 years. Think about what you planned for your future. Will you have children? Will you go down to a one-income household? These factors will play a role in how much mortgage you should take on to keep it affordable.

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Why Lenders Use Gross Income

The main reason lenders rely on your gross income rather than the net income is its reliability. Your net income is your total salary minus taxes and other deductions. These deductions could change often, so using your net income might give lenders inconsistent results. For example, if your company changes insurance plans or you change your tax filing status, your net income may change. Even if it’s only a $100 difference, it may still alter your ability to secure a loan.

Another reason lenders use gross income is that it’s a number you likely know off the top of your head. If someone asks you how much money you make per year, you probably know the salary your employer pays you better than the amount of your paycheck and how it converts into your annual salary. For example, it’s much easier to rattle off $75,000 per year rather than figuring out how your $5,267 monthly check converts into an annual salary.

How Lenders Use Your Gross Income

Lenders use your gross income to determine the maximum amount of your loan payment. Each loan program is different, but as a general rule, you can use the conventional loan guidelines of 28% and 36%. In other words, you can have a mortgage payment that is up to 28% of your gross monthly income. But lenders will also look at your total debt ratio. This is the total of all of your monthly debts including your mortgage payment – this figure shouldn’t exceed 36% of your gross monthly income.

Why You Should Focus on Net Income

Now just because a lender focuses on your gross income doesn’t mean you should use this figure. Your net income is the money you actually take home. This is the money you can use to pay your bills. You want to make sure that the mortgage payment you take on fits into that budget.

A good way to figure it out is to put the potential mortgage payment into your monthly budget. Are you comfortable with the payment? Do you have enough money left over after paying your bills to cover your living expenses?

If you focused on your gross monthly income, you might take on a mortgage payment that exceeds what you bring in or what you can comfortably afford. Some people don’t want to take on debts that eat into their disposable income. Many borrowers don’t want to live paycheck-to-paycheck. These are all reasons why you should focus on the net income to make sure you are taking on a loan you can afford.

Your lender will focus on your gross income, so make sure you have those numbers handy when you apply for a loan. But when you think about what you can afford, your net income is a better figure to consider to ensure that you only take on what you can afford.

How Much of Your Monthly Income Should be Spent on a Mortgage?