Buying a home, why do they use gross income?

[Grmnshplvr]

When doing a budget calculator on how much home you can afford why do they always ask for gross income? I don't bring that amount home why would I use it to budget how much house I can afford?
There is a big difference in our gross and net income!

 

[morgan98]

I assume because it is a common denominator for everyone. Some people are in higher tax brackets, or max out their 401k or have very expensive or (cheap) employer provided medical. That is what can make someone's net income fluctuate so dramatically.

That is why for purchasing a home, I would do a personal budget of what your take home is a month (after retirement contributions, medical, tax etc) and back out any other expenses you have. This should give you a ballpark of what you think your mortgage should be. Don't forget to consider real estates taxes and homeowners insurance too. Then by knowing your monthly amount and knowing an interest rate you can back into the amount of the loan.

ETA: I think this is also the quick way to get to a maximum budget amount.

 

[supersnoop]

When doing a budget calculator on how much home you can afford why do they always ask for gross income? I don't bring that amount home why would I use it to budget how much house I can afford?
There is a big difference in our gross and net income!

Probably because a home purchase is going to change your tax situation dramatically.

 

[Anthony1971]

Probably because a home purchase is going to change your tax situation dramatically.

This may or may not be true... While yes you will likely get more money back on your taxes you forgo the standard deduction. For example a married filling jointly had a standard deduction of 12,200.00 in 2014 so unless your interest payments, property taxes, state taxes, charitable donations and other less common deductions reach that you will still only have the standard deduction.... if your total deductions are say 13,000 you have only realized a tax break of your federal tax on 800.00 lets your bracket is 30%.. your tax benefit from owning a house will be 240.00. Please also look into alternative minimum tax in simple terms you can only write off so much in deductions for an income level. For example (not based on fact) if you make 80,000 in a year and you can come up with 50,000 in deductions.. you will still pay taxes as if you only had 30,000 in deductions.

 

[davper]

General rule of thumb, is you can have a debt to income ration of 28%. The total of all your debt (CCs, Mortgage, child support, car & student loans, etc.) cannot exceed 28% of your gross income.

So if your gross income per month is 10,000, your debt cannot exceed $2,800 in total debt payments each month. Using this example, if your current debt is $1,000 per month, your new mortgage payment cannot exceed $1,800 a month.

Again, this is a general rule of thumb. Not iron clad law. Banks make exceptions all the time.

 

[lanejudy]

When doing a budget calculator on how much home you can afford why do they always ask for gross income? I don't bring that amount home why would I use it to budget how much house I can afford?
There is a big difference in our gross and net income!

You're right, it can be a big difference. However, gross income is a standard that puts all at the same point to start the process of looking at your financial picture. Payroll deductions vary widely -- taxes, medical insurance, life insurance, retirement savings, flexible spending accounts, wage garnishments, etc. Others pay all or most of those items on their own, not through payroll deduction. Starting with net income creates too many variables of what other expenses have or have not been accounted for.

You may be *approved* for a higher amount based on gross income -- but you may only feel comfortable with a lower monthly payment. But it is up to you, the consumer, to know your own needs/expenses. I wouldn't rely entirely on an internet-based calculator; good old fashioned pencil and paper, listing out your expenses then see how that compares. Be sure to include expenses that occur less often (insurance payments, car registrations/inspections, taxes, etc.)

Good luck with the house purchase!

 

[tzolkin]

This may or may not be true... While yes you will likely get more money back on your taxes you forgo the standard deduction. For example a married filling jointly had a standard deduction of 12,200.00 in 2014 so unless your interest payments, property taxes, state taxes, charitable donations and other less common deductions reach that you will still only have the standard deduction.... if your total deductions are say 13,000 you have only realized a tax break of your federal tax on 800.00 lets your bracket is 30%.. your tax benefit from owning a house will be 240.00. Please also look into alternative minimum tax in simple terms you can only write off so much in deductions for an income level. For example (not based on fact) if you make 80,000 in a year and you can come up with 50,000 in deductions.. you will still pay taxes as if you only had 30,000 in deductions.

Thank you for bringing up the standard deduction.

I know many people who justify things as being "tax deductible" or "saving money on their taxes", but their total deductions are still less than the standard so it has no impact. They don't do their own taxes, so they don't realize this.


As far as the net vs. gross income question, people also vary widely with how much tax they have withheld and this can make a big difference in how their net income appears. For example, lets say you and I both work for the same employer (so healthcare, etc, are all the same) making $50,000 gross but I have completed my W4 so that I get a much larger paycheck each week and almost nothing back during tax season. You may think that your net income is much lower than mine (because your paycheck is less), but when you get your tax refund at the end of the year it will even out that we both wind up with the same net income. DH has worked with clients who had their withholding at 0 and were getting back $12,000+ in a tax refund. That's $1000 a month that could be going toward their mortgage or other expenses. But if you asked them what their "net income" was they wouldn't factor that $12,000 back in, they would just say the amount of their monthly paychecks.

 

[tink9702]

Also don't forget to factor in heating/cooling costs, maintenance costs etc. for the new house. It adds up very quickly depending on where you live and what systems the house has, how old it is etc. So even if you can afford the mortgage, can you afford to upkeep the house too?

 

[elgerber]

General rule of thumb, is you can have a debt to income ration of 28%. The total of all your debt (CCs, Mortgage, child support, car & student loans, etc.) cannot exceed 28% of your gross income.

So if your gross income per month is 10,000, your debt cannot exceed $2,800 in total debt payments each month. Using this example, if your current debt is $1,000 per month, your new mortgage payment cannot exceed $1,800 a month.

Again, this is a general rule of thumb. Not iron clad law. Banks make exceptions all the time.

The general guidelines are 29/41%. 29% for the housing percentage and 41% for the overall debt. This is for manually UW loans however. I work in mortgage and we go up tp 45% on the total debt for conventional loans (this is within normal guidelines) and up to and even over 50% on government loans.

Also, when using calculators, just because it shows you can afford/qualify for a certain amount, by no means do you have to spend that amount .

 

[tvguy]

When doing a budget calculator on how much home you can afford why do they always ask for gross income? I don't bring that amount home why would I use it to budget how much house I can afford?
There is a big difference in our gross and net income!

Gross income gives them a better idea of your real income. Net income is after optional tax deferred deductions such as 401's and Flexible spending accounts. Just the lending looking at what money you could shift to making the house payment is you had unexpected expenses that could not be put off.

 

[usd2bmd]

When we were first looking for our house 20 something years ago, we sat down and figured what we were comfortable spending in order to maintain a lifestyle that we were comfortable with. This figure was considerably less than the bank wanted to lend us. But had we taken what they were offering we could have bought a wonderful home. We just wouldn't have been able to buy much more. I am not sure how much this has changed because we are still in the small house we purchased then. I don't have to have the biggest/best house in the neighborhood. I just need one that fits us.

I think

 

[NY Pirate Princess]

I can't seem to quote previous poster but this is what you should do. Forget the calculators and get a real idea of what you can afford. When I went looking for my first house in 2005 the bank qualified me for a $200,000 on my own with an annual salary of $22,000. I guess they expected I would work nights too, if you get my drift. Housing bubble anyone? I bought a $70,000 first home. Don't let anyone else tell you what you can afford, you figure it out yourself. A good buyers agent will also sit down with you and run real numbers and send you away if you shouldn't be buying a home, but don't count on that either.

You should look into pre-purchase housing counseling classes in your area. These classes will teach you everything you need to know about what is likely to be the largest financial transaction in your life. They will teach you all the elements of home buying and maintenance, run your credit, and discuss your options. I can't recommend housing counseling enough.

 

[Minniesgal]

It is essentially a rule of thumb, your gross indicates how much you can afford to repay.

For what it is worth I've paid a mortgage for the last 23 years and should be finished next year and I would never believe we could afford what they would lend us. We never borrowed half what the bank would have given us.

 

[seashoreCM]

It's easier to qualify if you use gross income in the calculations.

 

[kymom99]

You're right, it can be a big difference. However, gross income is a standard that puts all at the same point to start the process of looking at your financial picture. Payroll deductions vary widely -- taxes, medical insurance, life insurance, retirement savings, flexible spending accounts, wage garnishments, etc. Others pay all or most of those items on their own, not through payroll deduction. Starting with net income creates too many variables of what other expenses have or have not been accounted for.

You may be *approved* for a higher amount based on gross income -- but you may only feel comfortable with a lower monthly payment. But it is up to you, the consumer, to know your own needs/expenses. I wouldn't rely entirely on an internet-based calculator; good old fashioned pencil and paper, listing out your expenses then see how that compares. Be sure to include expenses that occur less often (insurance payments, car registrations/inspections, taxes, etc.)

Good luck with the house purchase!

When I bought my first house, my realtor, who was a family friend, told me I could get a loan for as much as X but she recommended I stay under Y. Great advice. Not everyone thinks that way, unfortunately.