When you get into personal finance, you may hear about the 10/20 or 20/10 rule. But what does this mean?
The 10/20 rule refers to how much your take-home pay should go toward paying off consumer debt. No more than 10 percent of your monthly take-home pay should go to this type of debt. And no more than 20 percent of annual pay should go to it.
Take a closer look at the 10/20 rule to get a better idea of how to use it and what else you can do to take control of your debt and finances.
When learning how to manage your finances, you will start reading about budgeting, and one of the terms that come up often is the 20/10 rule. This rule states that you shouldn’t have consumer debt that adds up to more than 20 percent of your yearly take-home income. The same rule says that this debt also shouldn’t add up to more than 10 percent of your monthly income.
This guideline is used to help people understand the amount of debt they carry and how to limit it. It is important for your financial health that you understand how to budget your money and what you need to do to get started.
When it comes to following the 20/10 rule, you should be aware of a few more important things.
The 20/10 rule has been set to help people remember to add up their debt and compare it to their annual income. This rule can help you see if you are spending too much money and help you to limit any future borrowing. When looking at the two main parts of the rule, remember that it is guidance for consumer debt.
The 20-percent part means that the amount you spend from your yearly income should not exceed 20 percent of what you make. This takes into account all consumer debt and annual net or after-tax income. This also does not include your mortgage debt.
The 10-percent part helps break it down into a smaller time scale. This is to tell you how much monthly income goes to consumer debt. Again, this should not include mortgages. What you pay each month in consumer debt should be less than 10 percent of your monthly income.
You won’t get a handle on your finances until you deal with your budget. Not everyone needs to have a place for every penny, but everyone should have some idea of a budget if they want to have a solid financial plan.
With this plan, you have just two calculations to do. The first step is your monthly net income. This is the amount you get after taxes each month. Take 10 percent of that, and that is what goes to debt each month – at the most. So, if you make $4,000 a month, then $400 is what should be allocated to debt each month.
Next, you need to look at your annual debt obligations. You get this by multiplying everything by 12. So, for the previous figure of $4,000, the yearly income would be $48,000. This means that yearly debt shouldn’t be more than $9,600.
While it doesn’t include your mortgage, these debts are included:
*Mortgages are often allowed to be no more than 43 percent of annual income. This is already double the 20/10 rule and part of the reason behind its exclusion. Mortgages are also not included because they are considered good debt and slightly valued differently.
If your debt obligations aren’t falling into this rule, this is likely why you are struggling financially. The 20/10 rule will help you overcome your current financial struggles. It will help define the maximum concrete amount of debt you can carry, giving you a framework for your finances.
By calculating these numbers, you can start to set financial goals and get your debt paid down to fit within the framework. Think of the 20/10 rule as a way to help you set your financial goals. From there, it is up to you to start creating better habits.
The main advantage, especially if you aren’t budgeting already, is that it lets you focus on where your money is going and how much of it goes where. But it also helps you set limits on debt and borrowing. It is also a good starting place for managing finances and setting guidelines.
One disadvantage of this plan is that it doesn’t include your mortgage. This can make it a bit confusing. It also can be difficult to follow for those with student debt.
Once you have started digging into budgeting, you will find something called the 70-20-10 rule. We have already discussed a bit about the 20/10 rule, but what about the ‘70’ part of it? The 70-20-10 is one of the finance frameworks out there that people use to help with their budgeting.
If you have looked at sample budgets and thought they were complex, this may be the right one for you. If you want to be in more control and not stunted with too much micro-managing, then the 70-20-10 is likely for you.
The numbers add up to 100, with each number representing a percent. The numbers refer to where you should allocate your take-home pay. With this type of budgeting, 70% goes to spending, 20 percent goes to saving, and 10 percent goes to giving if you are debt free. If you have debt, you should apply the 10 percent to debt payoff.
In contrast to the 20/10 rule, the 70/20/10 takes a broader look at your financial picture. The following takes a more detailed look at the allocation of each percentage in your budget.
*Please note that these are maximum limits for the 70 and 10 percent categories, not a spending starting point. In contrast, 20 percent is a minimum you should be saving.
Which system you decide to base your budgeting around depends on you and your spending habits. If you haven’t budgeted before, start with the plan that appeals to you directly. Many recommend trying to work through both. You can use what is best for you and toss the rest.
If you are sinking into debt and either of these plans seems overwhelming, don’t hesitate to ask for help. You may find the debt is climbing, and you are unable to get out of it. In this case, a debt management plan may be your best route. With this, you close existing accounts and have a credit manager that helps you settle your debts.
While it may be intimidating to reach out, continuing to spiral downward financially can have effects that last for years. There are many free helplines and sites that will help you get your debt managed and under control.
The following provides the key takeaways you should keep in mind when applying the 20/10 rule.
It is important to remember that if your finances are working, you are doing it right, but if you are looking at the 20/10 rule, you likely have some learning to do. Don’t be afraid to start budgeting. It can be intimidating, but the more you start to work with it, the easier it will get. Start small and set simple goals. From there, you can start snowballing –getting debts paid down and meeting larger financial goals.