The 20/10 rule is a simple guideline that sets the maximum limits for consumer debt payments to no more than 20% of your annual income after tax deductions and no more than 10% of your monthly income after tax deductions.
What is the 20/10 rule?
The 20/10 rule establishes the boundaries that a portion of your annual and monthly income should go towards repaying consumer debt. This rule can help you determine if you are spending too much on debt payments and limits further borrowing you may want to undertake.
How to use the 20/10 rule
The 20/10 rule is easy to use as it only requires two simple calculations to ensure you’re on the right track.
Start with your monthly income after tax deductions, which is the amount printed on your paycheck or deposited in your account each month. Multiply this amount by 10%. This is the amount you should be spending on debt payments each month according to the 20/10 rule. For example:
$5,000 monthly × 0.10 = $500
If you make $5,000 monthly, your total monthly consumer debt payments should not exceed $500.
Then, look at your annual debt obligations. Multiply your monthly income after tax deductions by 12 to get your annual income after tax deductions. Then, multiply that amount by 20%.
Your total current consumer debt should not exceed that number. For example:
($5,000 monthly × 12 months) × 0.20 = $12,000
If you make $5,000 monthly or $60,000 annually, your total annual debt should not exceed $12,000.
Note: Always use your income after tax deductions for these calculations, not your gross salary. Your income after tax deductions is the amount you actually have available to spend each month.
If your debt obligations do not fit within the figures you calculate, a large portion of your income may be going toward paying off debts. This can cause financial strain.
The 20/10 rule can help you in two ways. It can provide you with a principle for managing your money by setting a maximum limit on the debt you carry, and it can give you a framework for taking control of your finances.
By calculating the maximum amount you should allocate to debt repayment, the 20/10 rule can help you set goals to work toward. This can assist you in identifying areas where you need to change your financial habits while limiting excessive borrowing and starting to pay down consumer debt.
20/10 rule vs. 70/20/10 rule
The 20/10 rule does not address how much you should spend in other categories, such as living expenses or saving for retirement. Instead, it only considers the amount of debt you carry.
The 70/20/10 rule, on the other hand, looks at a more complete financial picture by setting limits on other spending as well.
According to the 70/20/10 rule, you should spend:
- 70% of your after-tax income on living expenses, such as food, childcare, insurance, discretionary expenses, and your rent or mortgage payment
- 20% on savings, such as an emergency fund, retirement accounts, college funds, or other savings goals
- 10% on consumer debt, such as credit card payments or car loans
Note: Under the 70/20/10 rule, the 70% and 10% are maximums; you should not spend more than those percentages of your income. The 20% is a minimum; you should allocate at least 20% of your income to savings.
Both
The 20/10 rule and the 70/20/10 rule provide a framework for managing your money, limiting your spending, and assessing any debt you plan to take on.
The system you use depends on your personal spending habits. You may need to experiment with both options to determine which is the best tool for you.
Need Extra Help? Don’t Worry
You may find it challenging to keep your debt payments within the guidelines suggested by the 20/10 rule. If this is the case, don’t hesitate to ask for help, whether from trusted family and friends or from a financial professional.
If your debt becomes unmanageable, you may want to consider a debt management plan, which involves closing your current credit cards and allowing a financial advisor to negotiate with your creditors on your behalf. Financial counseling services will work with you through this process, developing a repayment plan for all the debts you owe, and guiding you toward a better financial future.
Frequently Asked Questions
Why don’t mortgage payments count in the 20/10 plan?
Mortgages and housing debt are considered “good debt,” as opposed to consumer debt. A home is an investment, and the mortgage builds equity with each payment you make.
If I follow the 20/10 plan, how much should I save from my salary?
You should aim to save at least 20% of your income after tax (net) or 10% of your income before tax (gross).
What if my debt is more than 10% of my net salary?
There are many things you can do to reduce your debt. Focus on eliminating revolving debt like credit cards by paying more than the minimum payment, and joining a debt reduction plan. You can also try to consolidate your debts to bring them below the 10% payment threshold.
Source: https://www.thebalancemoney.com/should-you-follow-the-20-10-rule-for-debt-management-4164476
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