What is Gross Monthly Income? Why Does It Matter? – Facet Wealth
“Gross monthly income” may sound like some sort of nerded-out accounting term, but it’s actually a simple number with some very far-reaching consequences.
To apply for a loan, a credit card, or any other form of credit, it’s important to know that number.
Lenders will ask. If you’re contemplating a business partnership, the potential partner may ask. Although it may seem impolite, it’s possible that the question could even come up during a first date.
In a household, a lender may ask for the gross household monthly income, which would generally mean the income of you and your spouse.
Here’s what it is and why it’s important.
In the financial world, “gross” means the total amount before any deductions. So, for example, if a business sells $1 million worth of products, the gross revenue is $1 million before taxes, salaries, and other business expenses.
The same is true for individuals. Gross monthly income is all the money earned from:
The easiest way to calculate gross monthly income is to take all of the money earned or received in a year and divide that amount by twelve.
This average amount is particularly helpful when some sources of income—such as bonuses or side hustles—may produce different amounts of income each month (or some months, none at all).
Keep in mind that when lenders and financial institutions ask for gross monthly income, they only ask about cash and cash equivalents.
Government and private programs that provide non-monetary benefits—such as Supplemental Nutrition Assistance Program (SNAP)—are not included. Nor is money your employer may deposit into a Health Savings Account (HSA) or matching funds deposited into your (401(k).
Anyone extending credit wants assurances that you’ll be able to pay your obligation—whether it’s a mortgage, the monthly payment for a new cell phone, or a loan. They’ll analyze your credit score, which will tell them whether you’re a good risk. But a credit score won’t tell them how much money you make.
As a rule of thumb, lenders don’t want your mortgage payments to exceed 28% of your gross monthly income and your total debt payments (including mortgage and other loans) to exceed 36% of your gross monthly income.
Some lenders may be willing to exceed those limits, but may charge a higher interest rate. This is one reason why it may be wise to pay down other debts—such as credit cards and auto loans—before applying for a mortgage.
Knowing your gross monthly income can also be helpful even if you’re not planning to apply for a loan soon because it can help determine your financial health.
Gross monthly income is one of the two numbers you need to calculate your debt-to-income ratio (DTI).
DTI is exactly what it sounds like: The percentage of your income that goes towards paying your debts.
For example, if your gross monthly income is $6,000 and you pay $2,000 monthly towards debts (mortgage, auto loan, credit cards, other loans), your DTI is 33%.
This percentage is generally considered a comfortable amount of debt to manage, and you’ll probably have money left over after paying all your bills.
However, if your debt payments are $3,000, your DTI shoots up to 50%. This may not be enough money to live comfortably.
Obviously, the lower your DTI, the better. Once DTI gets too high, affording all of life’s expenses becomes more challenging, and lenders may be reluctant to expend credit.
Net monthly income is the actual amount in your pocket (or bank account) after deductions: federal and state income taxes, Social Security/Medicare, health insurance, and retirement plan.
If your only income is your paycheck, your net monthly income is the amount actually deposited into your bank account by your employer each month.
Knowing your gross monthly income is critical for formulating a budget, calculating tax liabilities, choosing a percentage to invest for retirement, and several other financial decisions. It’s a number you have to know when applying for a loan or renting an apartment.
A CFP® Professional at Facet Wealth can help you use your gross monthly income as the starting point for more informed financial decision-making..
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