Your debt-to-income ratio is a percentage figure that compares how much debt you have vs. how much you earn before taxes, according to Bankrate's Erin Peterson. This number is important because the lower the percentage, the better your odds of getting a good interest rate on everything from a new car to a new home. A credit score also helps to determine interest rates, but it stands alone and the ratio is not a factor in this three-digit number.
Distinction
Your debt-to-income ratio tells lenders how much debt you will be able to take on and, thus, determines how much they are willing to lend to you, according to Peterson. On the other hand, your credit score is a record of how good you've been about paying your bills on time. Unlike the debt-to-income ratio, the credit score does not take into account your income at all.
Calculation
You can figure out your ratio by adding up all of your monthly payments (don't count basic expenses like food, gas or clothes) and dividing that by how much you make each month before taxes are taken out. The lower the number, the bigger the loan you'll qualify for. On the other hand, the higher the number for your credit score, the better your odds of qualifying for good rates on a home loan. The Consumer Federation of America reports that scores range from 300 to 850, with the best rates given to those whose scores are 700 or higher. Anything under 600 is considered high risk. Unlike the debt-to-income ratio, you can't determine the credit score on your own, but you can get a feel for where the number comes from; 65 percent of the number is derived from your ability to pay debts on time and from your total debt load, according to Fair Isaac Corp's MyFICO. Length of credit, new credit and mix of credit types are also factors.
Debt
The debt that is taken into account with the ratio is considered recurring debt. These monthly, ongoing obligations include car loans, credit card payments and student loans. Peterson notes that in some cases lenders will take your existing mortgage into account when determining the debt-to-income ratio -- whereas other lenders won't -- but the concept of how the number is derived remains the same. Credit scores always take into account all recurring debts, and this includes an existing mortgage, to determine the final number, according to the Consumer Federation of America.
Qualification
If you calculate that your debt-to-income ratio is 36 (or less), that means your overall debt is no more than 36 percent of your total income. That's a good thing, according to consumer resource organization Nolo, becasue higher than that, and you'll have a hard time qualifying for the best rates. That's not to say you won't get the size of the loan you need to finance your home, but you may pay big over the long run with a much higher interest rate, according to Peterson.
Significance
Though your credit score is not figured into your debt-to-income ratio, it plays a factor in your overall likelihood of getting a loan you can afford. According to Peterson, lenders evaluate debt-to-income ratio, as well as how long you've been in an existing home (or job). You can also use a good ratio as a means of negotiating a better deal on your loan.
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