Definition of gross income for mortgage calculation
Mortgage companies use gross monthly income when calculating the debt-to-income (DTI) ratios of loans. Gross income is the amount of income earned before taxes are deducted.
Mortgage companies use gross income because it simplifies and streamlines the mortgage approval process. Depending on the income type, gross income may mean different things.
Salary and hourly employees
Income from a salary or hourly wage is easiest to calculate. If the borrower receives an annual salary of £39,000, then the gross monthly income is £3,250. The gross income for these two income types is always calculated before tax deductions or cost of benefits.
If the borrower is paid hourly, then the hourly wage is multiplied by the number of hours each week. The result is multiplied by 52 (weeks in a year) then divided by 12 (months).
Income derived primarily or solely from commissions must be averaged over two years. Most lenders review two years' tax returns to make these calculations. Income one month could substantially exceed other months, so instead of using the minimum received each month, the average is calculated.
Many lenders require the income average span of two years plus the year-to-date income. In some cases, when the loan is especially strong, the lender may average over only one year and the current year-to-date income. If the borrower claims any unreimbursed employee expenses, then those are reduced from the monthly gross income.
Self-employed borrowers must provide two years' tax returns when qualifying for a mortgage. Often these may include corporate tax returns depending on the type of business owned.
Even if the borrowers provide themselves with a payslip, the tax returns are required. The income is not based on gross revenue but on the net revenue after expenses but before taxes. Some expenses may be added back in, such as depreciation and depletion because they are paper write-offs and not cash expenses for the year. Many lenders will not accept profit-and-loss statements, but will only consider the tax returns.
Some forms of non-employment income are not taxable. Child support and Social Security benefits are two examples.
Child support is never taxable and Social Security income is only taxable under certain conditions. If the income is not taxable, then the income is raised or "grossed up" by 125 per cent of the actual amount received. This is so it has the same qualification power as taxable income.
Other forms of non-employment income include alimony and pensions. These income types are not eligible for grossing up, and the gross income is based on the actual received amount before taxes.