Why are mortgage loans based on a Gross income instead of my Net?
PhotoMan asked:
Doesn’t make any sense to figure what I can afford based on what I earn BEFORE the government takes their cut. Why don’t they do it based on what I have left over?
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Doesn’t make any sense to figure what I can afford based on what I earn BEFORE the government takes their cut. Why don’t they do it based on what I have left over?
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Tags: Gross Income, Mortgage Loans
December 2nd, 2008 at 2:11 pm
The bank isn’t going to attempt how your net is adjusted by taxes (will you get money back or pay more) and you can change your net by simply telling your HR department you want to take more deductions - you’ll have to pay the money back at tax time (if you took to many) but if the short run your net will be higher than it should be.
December 4th, 2008 at 10:32 pm
It is for simplicity. Because of different status, exemptions, insurances, retirements plans, etc. two people have the same gross but have very different nets.
They estimate taxes and other aspects of spending to determine what loan you can afford.
December 5th, 2008 at 11:53 am
People do have different tax exemptions then others but banks do look at what is called disposable income when underwriting the loan. Disposable income is what you have left over. Also the automated underwriting systems, that almost all lenders use, do the same. For instance you have on your application 2 dependents ages 6 and 10 and the application does not show child support payments. The underwriter will want to know if child support payments are required by the other parent and if so you can gross that income up 25% because its non-taxable.
So they do look at disposable income when underwriting the loan because you need to demonstrate the capacity to repay your mortgage. Now most of this is done by automated underwriting engines that have built in risk models designed around three areas of lending also called risk layering. Those are income, assets, and credit. What do you make? How much do you keep in savings, investements, and reserves? And how well do you pay your obligation?.
Lenders use ratios, called debt-to-income ratios, to determine the risk layering involved in making a loan decision. If you have a high debt ratio but have 30 months of mortgage payments, also called reserves, in the bank and a good credit score you could compensate for the high debt ratio because you have money in the bank should something happen. Everything revolves around risk and historical data when tweeking these automated systems. I’ve seen someone with a 60% debt ratio, which is extremely high, get approved but they had enough money in the bank to pay cash. No two people or loan are the same.
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