Why do lenders set 31% of gross income instead of net income (home loan, 401k)

[aneftp]

To me, what your real "net take home pay" is much more important than the gross pay.

Why do most national lending agencies set the "gross pay" instead of "net pay" when determining if they can afford their mortgages?

Why don't they make it so it's 25% of "net take home pay"?

Most of my friends make 25-40K a month but they defer/redirect most of the gross pay into tax shelters (like defined benefits plans or safe harbor IRAs). But their real take home pay 50% of their gross.

Personally I do not think anyone should own a home unless they can make at least a 5% downpayment (because if they needed to sell a home RE commissions will cost them at least 5-6% if they needed to sell) and people need at least 6 months of mortgage payments left over AFTER closing. (They should exclude retirement accounts unless the people buying are retired and have significant assets but than again, those people would put down much more).

[jctx]

Your friends have terrific income.

I have wondered the same thing for a long time. We pay bills in "real dollars" and our mortgage in "real dollars" so why not compare apples to apples? It just seems silly and adds another step into our budgeting and calculations for no apparent reason. It seems like your friends qualify for much more costly homes even though their true take home dollars wouldnt touch that same home price in "net".

[Fant]

I think its because the net amount can be changed based on your withholdings +/- 5-10%. With the gross, they know what your tax rate can be max and they can take an educated guess at how much you should be able to take home. If you make 25-40k a month gross, you should be able to afford a bigger home as you dont need to defer alot of it to 401k etc. However I agree it should be safer for the banks to consider net pay.

[johnsonkk]

Originally Posted by aneftp

Most of my friends make 25-40K a month but they defer/redirect most of the gross pay into tax shelters (like defined benefits plans or safe harbor IRAs). But their real take home pay 50% of their gross.

$40k a month is around half a million a year. Your friends have the means to pay off most home loans in one year, maybe two.

Suprising fact is a lot of wealthy homeowners decided to take adjustable rate mortgages. Wealthy may be next in line in home crisis | Reuters

[aneftp]

Originally Posted by johnsonkk

$40k a month is around half a million a year. Your friends have the means to pay off most home loans in one year, maybe two.

Suprising fact is a lot of wealthy homeowners decided to take adjustable rate mortgages. Wealthy may be next in line in home crisis | Reuters

I read the article. The problem is not the prime borrowers or even the ARMs. It's those who put very little money down. I'm not a mortgage broker but I still believe ARMs have their place in the mortgage business. ARMs should have only been targeted to young doctors/lawyers/investment bankers who have a potential to make a solid living. ARMs should have never been targeted to teachers/nurses/construction workers etc.

Higher income people have to protect themselves. If those homeowners put down 20%, than they would not have had a problem. Higher end areas in prime locations have not declined like the rest of the local markets. Say an area like Washington DC where the far off suburbs (like Prince William County or parts of Loundon County have declined 30%) but the inner affluent suburbs like McLean, VA have only suffered a 10-15% decline. If these higher income earners had been financially responsible, they will be able to sale for a lost and just rebuild their finances very quickly.

I know I will not get a lot of sympathy for this but making 500K a year does not mean you are "rich" and can pay off your mortgage in 1-2 years, especially in high cost living areas. Sure you are "well off" but not rich.

[Flamingo13]

I can't even wrap my head around your "problem" - speaking as someone who relies on disability income and is just happy to pay the mortgage every month, buy food and pay the utilities.

[aneftp]

Originally Posted by Flamingo13

I can't even wrap my head around your "problem" - speaking as someone who relies on disability income and is just happy to pay the mortgage every month, buy food and pay the utilities.

I agree with you 100%.

I can't fathom people who make in the mid six figure range having any problems. It's just people overspending and not saving. They can lose that high income job and have very little savings to sustain their lifestyle.

I just think the government needs to start using net income. Homebuyers need to have that "cushion" available in case of emergencies or health problems. This cushion should be built into the net income requirement. Or the government should just reduce the gross income down to 25% altogether so this prevents people from overspending. It's human nature to try to outspend your friends. Sad but true in this day and age.

[jctx]

Wont the banks take the cushion factor into consideration when providing mortgage loans? I thought people had to be able to demonstrate X number of months worth of mortgage payment money in their bank accounts on closing, just in case of emergencies or something.

[johnsonkk]

For those that are living beyond their means, and trying to keep up with the Jones', it's hard to think the government would bail out anyone in the mid, 6-figure salary range because their net salary is low. Especially when it's due to extras such as vacation homes, vehicles, toys, etc. Great summary on this is a short book that still is accurate as the day it was published.

Amazon.com: The Millionaire Next Door: Thomas J. Stanley, William D. Danko: Books

[LIOC]

Originally Posted by aneftp

I agree with you 100%.

I can't fathom people who make in the mid six figure range having any problems. It's just people overspending and not saving. They can lose that high income job and have very little savings to sustain their lifestyle.

6 figures may not be as much as you think in some parts of the contry.