Knowing the difference between your gross income and your net income can not only help you determine if you qualify for a loan, but if you can truly afford the payments on it. Lenders looking to determine your ability to repay might consider your gross income, net income, or even your residual income so it pays to know the definition of each.
Figuring out your Gross Income
Your gross income is made up of all your sources of income, including your wages, salaries, tips, commissions, bonuses, profits, rents, and any other form of earnings — before any taxes or other deductions are taken out. Therefore your gross income is likely to be the highest estimated income figure.
Interestingly, both gifts and inheritances are not considered income (though they may be taxed under separate guidelines).
Certain categories of income may be excluded from your gross income figure if you do not wish for them to be considered as part of an application for credit. These include alimony or spousal support, child support, and public assistance programs.
Surprisingly, mortgage lenders and home equity lenders will often consider your gross income when reviewing and underwriting your loan application. They will compare your monthly debts, including the new loan, with your gross monthly income to come up with a debt-to-income ratio.
Figuring out your Net Income
Your net income is also referred to as your “take-home” income because it’s what you literally take home after income taxes and other deductions are made.
Knowing your net income can help you determine a realistic and affordable monthly budget before taking on a debt (and the subsequent monthly payments).
It is worth noting that net income has an alternative meaning if you are self-employed or running a business. In these cases, net income refers to profitability or revenue minus total costs.
What is Residual Income
Residual income calculations take your net income calculation one step further and deduct your regular monthly expenses, like housing, utilities, food and childcare. Residual income is what’s left over each month after all of your basic needs are met and bills are paid.
Certain lenders and certain types of loans may have residual income requirements to help prevent over-leveraged lending. For example, VA loans to qualified military members have residual income requirements that are adjusted for the region you live in.
What about Income Taxes and Gross Income vs. Net Income
You may see both gross income and net income come up on your income tax filings. In this case, gross income refers to your total taxable income, which may exclude different types of nontaxable income.