Are debt service ratios based on gross income or net income?

Debt service ratios are calculated using gross income. This approach is widely adopted in the mortgage lending industry because it provides a more comprehensive view of the borrower's financial capability. Gross income refers to all earnings before any deductions, such as taxes and other withholding contributions. By analyzing gross income, lenders can ascertain the total income available to cover debt obligations, including mortgage payments.

Using gross income for debt service ratios allows lenders to have a standardized method for evaluating all borrowers, regardless of their individual tax situations or personal expenses. It also ensures that the assessment aligns with common lending criteria, as gross income typically reflects potential earnings without the impact of individual financial decisions, such as tax payments or other personal deductions.

In contrast, net income, which accounts for taxes and other deductions, can vary greatly among borrowers and may not provide an accurate picture of their ability to manage mortgage payments. Other options presented, such as including both gross and net income or using neither, do not align with the standard industry practice which relies solely on gross income for calculating debt service ratios.