There are two types of income: gross and net. Gross income is the annual salary a person earns. It is used to determine taxable income and for qualifying for loan programs. Gross income is very different than net income, which is a much more useful figure for budget planning.
Net income is basically a person's take-home pay. It is his earnings for a pay period minus any taxes or other set deductions taken from his pay. These other deductions could include health insurance, retirement contributions, court-ordered judgments or support payments.
Figuring Annual Net Income
Annual net income is how much a person actually clears over the course of a year. It is determined by taking the take-home pay amount for a pay period and multiplying it by the number of pay periods in a year. For example, if a person is paid bi-weekly, then she can determine her annual net income by multiplying her take-home pay amount by 26. This works best if her check is for the same amount every pay period.
While many people look at their gross annual income when taking a job and determining their monthly income, net income is the more valuable figure to examine. A job making £39,000 a year may seem like a lot of money, but if a person earning that amount is in a 28 per cent tax bracket, has to pay state and local taxes totalling 5 per cent, along with contributions to health care, that £39,000 a year gross pay turns into a much smaller amount -- closer to £25,025. That does not count any other possible deductions such as retirement or child support. In those cases, the annual net could be less than half of the gross annual income.
Effects of Loans
While lenders use gross income to figure the maximum payment and loan amount for any type of loan including home and auto loans, a potential homeowner really needs to keep an eye on her net income when looking at the true impact of a loan. She knows what her take-home pay is, which determines her actual budget. A home or car that is affordable on paper using gross income could become a millstone after all taxes, contributions and deductions are taken from her pay. A 28 per cent mortgage payment based on gross income becomes a 39 per cent mortgage payment based on net income at a 28 per cent tax bracket.