Do Mortgage Lenders Use My Net or Gross Income?

When contacting a mortgage lender for your first home purchase, you'll want to know the information they need so you are prepared to answer questions. Lenders often prequalify you over the phone to give you an idea of what you may be able to borrow. They ask a series of questions that help them determine your creditworthiness, liabilities and earnings. When asked how much you make, remember that they are interested in your gross income.

Mortgage lenders are interested in how much you make before you take any tax deductions or pay taxes on your earnings. Typically, you apply for a mortgage as an individual, rather than a business, so the lender is concerned with gross income, not net income. You must supply income information for all of the borrowers who will be responsible for the loan, including any co-signers or co-borrowers. Co-signers, unlike primary borrowers and co-borrowers, do not own the home, but their income can help qualify for the loan.

Lenders rely on debt-to-income (DTI) ratios to determine how much of a monthly payment you can reasonably afford. DTI ratios are expressed as a percentage and represent the relationship between your recurring monthly obligations and your gross income.

Most conventional lenders have benchmark DTI standards of 28 percent and 36 percent. This means that ideally you spend no more than 28 percent of your gross income on housing, including loan principal, interest, property taxes and insurance each month. They also want you to spend no more than 36 percent on housing and other monthly debts. Loans insured by the Federal Housing Administration have more lenient DTI ratios of 31 percent and 43 percent.

Lenders make sure that your gross income is stable and continuous. The benchmark standards used to determine this are that the borrower has received the stated income for at least two years. Your employer, or other source of the payments, also must verify that the income will likely continue for at least the following three years. When applying for a loan, you must provide the lender with tax returns, Forms W-2 or official self-employment income documentation, and recent pay stubs. The lender may also call your employer or obtain a written verification of your employment status.

Some income is exempt from federal taxes. Untaxable income includes certain disability and public assistance payments, military allowances and child support. The lender can add back a percentage of untaxable income -- or "gross up" -- making it higher. To gross up, the lender multiplies the gross income amount by the tax rate used on your most recent tax return. For example, if your most recent tax rate was 25 percent, the lender would multiply child support payments you receive by 125 percent to come up with the grossed-up amount.