Does the Bank Use Taxable Income or Gross Income to Determine if You Qualify for a Loan?

by William Pirraglia

    Banks and lenders use gross income, not taxable income, to decide whether you qualify for a mortgage or other loan. Gross income is your before-tax earnings. Your taxable income cannot be determined until you prepare your annual federal tax return, because you're able to deduct a number of expenses and personal exemptions that reduce your taxable regular income. Taxable income seldom reflects your current gross income.

    Banks use only your regular gross income to qualify you for a loan. They do not use occasional overtime pay or a potential annual bonus, unless you can convince your loan officer that you will receive one or both of these on a consistent basis in the future. Most banks request at least your last two pay stubs, which should also show your year-to-date earnings, to establish your amount of regular gross income.

    Your adjusted gross income, or AGI, is also calculated on your annual tax return. This amount might or might not approximate your regular gross income, depending on your eligibility for some deductions, such as qualified moving expenses. Because this amount is calculated only when preparing your annual tax return and does not necessarily reflect your current compensation, banks typically do not use this gross income figure.

    Your taxable income depends on numerous factors, and -- because it is calculated only once per year, on your federal tax return -- banks do not use this amount. Because this is a historic figure and because Congress often changes tax rules, your taxable income is not a reliable predictor of your ability to repay a mortgage or loan. Banks understand that you or your tax adviser use every legal means to reduce your taxable income.

    Self-employed borrowers, unless they are salaried employees of their own corporation, submit two years' tax returns, along with a current profit and loss statement for their company, to arrive at a gross income amount. For example, a sole proprietor might show $48,000 profit in each of the past two years. A current profit and loss statement might indicate that the company should have similar earnings in the current year. For qualifying purposes, the loan officer can assume that your gross income is $4,000 per month.

    You do everything legally possible to lower your gross income to its taxable level. By considering your regular gross income before tax withholding, banks give you the benefit of using a much higher income amount to qualify you for loans and mortgages. The bank also benefits, as your gross income is easily verifiable, and it indicates your earning power for repaying loans.

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    About the Author

    For 34 years Bill Pirraglia served as a senior executive in the banking industry. Since 2005, he has authored articles, blog entries, tips and advice columns, SEO web copy and two published books. He specializes in personal and business finance topics, along with legal articles for clients large and small.

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