BUDGETING, PERSONAL FINANCE
- Last updated:July 16, 2023
The 10/20 rule finance is a helpful budgeting trick to make sure you don’t get overwhelmed by debt.
So basically the 10/20 rule goes like this:
- The total amount you owe should not exceed 20% of what you earn in a year.
- Monthly payments must be kept below 10% of your monthly income.
In recent times, many individuals and households are facing financial issues withrising cost and mounting debtsso it is super crucial to have a grasp on our financial situation to make informed decisions.
Note: This may not be suitable for everyone as we are all in different financial situations.
Table of Contents
What Is The 10/20 Rule Finance?
This rule is very straightforward, it sets guidelines for managing debts and ensuring financial obligations remain within manageable limits.
The rule suggest:
- The total amount you owe should not exceed 20% of what you earn in a year.
- Monthly payments must be kept below 10% of your monthly income.
To apply it effectively, here are 2 essential components:
- Debt to income ratio. It gives you an idea of how much income is being allocated to debt repayment.
- Monthly payment percentage. this mainly focuses onindividual debts. (not exceeding 10% of monthly income)
How Do I Use the 10/20 Rule?
To unleash the full potential of the 10/20 Rule, you need to determine your maximum debt and monthly payment threshold.
Start by calculating your monthly income after tax. You can use theIRS websiteto calculate your tax. This should exclude all sources of income, such as your salary, freelance gig or any side hustles you may have.
Got you monthly income? Good, now multiply it by 20% to determine the maximum limit for total monthly debt payments.
Next, multiple 10% to your after tax monthly income to get the maximum threshold for each individual debt.
Example Of How To Use 10 20 rule
Let’s say, me, Mr Savvy is earning a monthly income of $5000. By applying the 10/20 rule, I will allocate a maximum 20% of my income ($1000) towards total monthly debt payments.
Additionally, I can also have my individual debts that don’t require monthly payments of no more that 10% ($500).
Now, imagine I have a car loan with a monthly payment of $400 and a credit card debt with a minimum payment of $100. These should fall within the 10% threshold for each individual debt.
Great! I was able to keep my debt under control!
Pros and Cons Of Using The 10/20 Rule
The main benefit to the 10/20 rule is that it limits your borrowing and the amount of debt you take on. However, you must also keep in mind that it has certain drawbacks. Take a look at the infographic.
Additional Information:
Student Loans
They can feel like a heavy weight on your shoulders, especially for recent graduates. The monthly payments can still eat up a significant portion of your paycheck, making it challenging to allocate funds towards other financial goals.
Mortgage or House Payments
Here’s the catch, the 10/20 Rule doesn’t directly consider mortgage debt as it often involve large amounts. This might give you an incomplete picture of your overall debt-to-income ratio and financial obligations.
Credit Cards
Credit cards often come with high interest rates, making it challenging to fit within 10% individual budget. Minimum payments may not be enough to make significant progress, resulting in prolonged debt repayment and mounting interest costs.
Conclusion
The 10/20 rule provides a valuable framework for budgeting and debt repayment as it helps to maintain a healthy balance between income and financial obligations.
However, it is important to know that it may not be perfect for everyone due to different financial situations.
Remember, the 10/20 rule is just one tool in your financial toolkit.
Free 60/30/10 Budget Spreadsheet
If you’re looking to save more of your income aside, try going for the 60/30/10 budget method where you’ll save 60%, spend 30% on your needs and the remaining 10% on your wants.
Here’s a FREE budget spreadsheet for you to use!
What is the difference between 20/10 rule of thumb and 70/20/10 rule of thumb?
The 10/20 rule of thumb is best for handling debts but has limitations on how you budget your money. The 70/20/10 rule however provides a more in-depth budgeting plan as well as debt management.
What are the disadvantages of th 60 30 10 budget rule?
The disadvantage is that you’ll have less to spend on your wants as most of your money will be going into your savings/debt repayment (60%).
how to use the 10/20 Rule?
Take your after-tax monthly income and multiply by 20%and 10%, respectively. Make sure 20% goes to savings and 10% is for consumer debts.
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