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The 20/10 Rule of Thumb

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The 20/10 rule of thumb states that your yearly payments on consumer debt should not exceed 20 percent of your after-tax income, and your monthly payments should not exceed 10 percent of your after-tax income.

This recommendation may assist you in reducing the total amount of debt you are responsible for, which is vital to both your overall financial health and your credit score. Having said that, it does have a few limitations.

Acquire the skills necessary to compute the 20/10 rule of thumb and become familiar with the benefits and drawbacks of using it.

What does it mean to follow the 20/10 Rule?

The 20/10 rule dictates that no more than 20% of your yearly take-home income and 10% of your monthly take-home pay should go toward paying off consumer debt.

This guideline may assist you in determining whether or not you are paying an excessive amount on debt payments, and it can also assist you in determining the maximum amount of new debt that you are prepared to take on.

The “20/10 rule” consists of two distinct parts:

  1. 10 percent of monthly income: The second section outlines how much of your monthly income should go toward the repayment of debt. This amount should be 10 percent of your monthly income. Your payments on your consumer debt should not exceed 10 percent of your monthly net income at any point throughout the month.
  2. 20 percent of yearly income is the amount of money that should be put toward paying off debt each year. This is the part of your annual revenue that should be used for this purpose. When all of your consumer debt is included in, the amount that you borrow shouldn’t exceed twenty percent of your yearly income after taxes (your net income).
The 20/10 Rule of Thumb

A Particle of Salt

The most important advantage of following the 20/10 rule is that it restricts the amount of money you borrow and the amount of debt you take on.

The creation of structure, which may make it simpler for you to manage your funds, is facilitated by having a specific guideline to follow.

Nevertheless, the 20/10 rule does have certain difficulties to consider. It is possible that your own financial position will determine whether or not you choose to adhere to it.

Pros:

  1. Restriction on borrowing and existing debt
  2. Concrete guideline for managing funds

Cons:

  1. Not included of rent, mortgage, or other housing expenses.
  2. Student loan debt may be challenging to manage properly.

Student Loans

If you have outstanding student loan debt, you may find that the figures in the 20/10 rule are too restrictive for you.

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If you follow the preceding rule and your monthly income is $5,000, and your monthly student loan payments are $400, then you will only have $100 left over each month to apply toward other consumer debt, such as a car payment.

This is because your monthly student loan payments take up half of your monthly income.

Although it is true that you should try to keep the total amount of debt you take on to a manageable level, it is not necessary to adhere to the 20/10 rule in order to have a comfortable life.

You should, however, strive toward paying off all of your consumer debt and reducing the total amount of debt you carry to a minimum.

If you just have student loans, it’s quite easy to go close to or even beyond the 20/10 level.

If you follow the 20/10 rule, you won’t be able to rack up any more consumer debt until you’ve paid off your college debts.

Mortgage

The 20/10 guideline doesn’t include your mortgage or rent payment. It applies exclusively to your consumer debt, which includes payments to the following entities:

  1. Cards granting credit
  2. Auto loans
  3. Student loans
  4. Other responsibilities pertaining to funding

If you apply for a mortgage and it will raise your overall debt-to-income ratio to no more than 43 percent of your monthly income, most lenders will give you approval for the loan.

The 20/10 rule allows for a maximum of 10 percent, although this is far greater than that.

How to Apply the 20-Ten Rule as a Rule of Thumb

The 20/10 rule of thumb is easy to use since it just asks you to do two straightforward calculations to determine whether or not you are on the right road.

Start with your monthly income that has been adjusted for taxes. This is the amount that is shown on your check stub or that is put into your account every month. That total must be multiplied by a factor of ten percent.

In accordance with the 20/10 guideline, it is the sum that you should allocate each month to the settlement of your debts. Take, for instance:

$5,000 per month multiplied by 0.10 is $500.

If you take home $5,000 each month, the quantity that you pay toward all of your consumer debt each month shouldn’t be more than $500.

Next, take a look at the yearly payments that are due on your loan. To calculate your yearly income after taxes, just double your monthly income after taxes by 12.

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This will give you your annual income. After that, multiply that total by a factor of twenty percent.

It is not acceptable for the amount of all of your outstanding consumer debt to be larger than that figure. Take, for instance:

($5,000 per month multiplied by 12 months) multiplied by 0.20 is $12,000.

If you take home $5,000 per month or $60,000 per year, the sum of all your debts should not exceed $12,000 per year.

Using the 20/10 rule might assist you in establishing objectives to strive for by estimating the maximum amount of money that you should be paying toward the repayment of your debt.

As you cut down on your borrowing and start paying off consumer debt, using this information might assist you in determining the areas of your financial routine that need modification.

If the figures you compute don’t match up with your debt commitments, then a disproportionate amount of your income may be going toward the repayment of your debt. It’s possible that this is putting a burden on your finances.

The 20/10 rule may be of use to you in two different ways. It can give you a framework for getting your financial situation under control as well as a guideline for managing your money by giving you concrete maximums for how much debt you carry, and it can give you a guideline for managing your money by giving you concrete maximums for how much debt you carry.

Do You Need Some Extra Help? Don’t Get Worked Up

If you are finding that your debt is becoming unmanageable, you may want to think about enrolling in a debt management program. This program requires you to cancel all of your existing credit cards and have a credit counselor negotiate with your creditors on your behalf.

If you are finding that your debt is becoming unmanageable, you may want to consider enrolling in Credit counseling services will help with you through this process, constructing a payment plan for all of the bills that you owe, and guiding you towards a more secure financial future.

It’s probable that you won’t be able to maintain your monthly payments within the parameters recommended by the 20/10 rule of thumb for managing debt.

If this is the situation you find yourself in, do not be afraid to seek assistance, whether it be from dependable members of your family and circle of friends or from a financial expert.

The 20/10 Rule of Thumb. Source: Freepik

Difference Between the 20/10 Rule of Thumb and the 70/20/10 Rule of Thumb

The 70/20/10 rule of thumb, on the other hand, takes into account a more comprehensive view of one’s financial situation by imposing restrictions on one’s other types of expenditure as well.

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The 20/10 rule of thumb does not address how much you should spend on other areas, such as saving for retirement or paying for day-to-day living expenditures, for example. Instead, the only thing that is considered is the total amount of debt that you have.

You should spend your money as follows, according to the 70/20/10 rule:

  1. You should spend at least 70 percent of your income that is left over after taxes on essentials like food, child care, insurance, and other non-essentials like rent or a mortgage.
  2. 20% of your income should go into savings, including your emergency fund, retirement accounts, college fund, and any other savings objectives you have.
  3. 10% applied to consumer debt, including monthly payments for credit cards and auto loans, for example.

Both the 20/10 rule and the 70/20/10 rule give a framework for managing your money, restricting your spending, and evaluating any debt that you intend to take on. Both of these rules may be found here.

Your own spending patterns will determine which method works best for you. It’s possible that you won’t know which tool is best for you to utilize until you experiment with both of the available choices.

What should I do if the amount of my debt is more than 10 percent of the money I bring home each month?

There are a variety of actions you may do to bring down the total amount of your debt.

You might also give debt consolidation a go in order to lower your monthly payments down below the 10% criteria.

You should prioritize eliminating revolving debt such as credit card debt by making payments that are more than the minimum needed payment and enrolling in a debt-reduction program.

How much of each paycheck should I put away for savings if I am going to stick to the 20/10 plan?

You should make it a goal to set aside at least 20 percent of your income (net) after taxes and at least 10 percent of your income (gross) before taxes.

Why aren’t payments made toward the mortgage part of the 20/10 plan?

In contrast to consumer debt, mortgages and other forms of housing-related debt are seen as “good debt.” Each payment that is made toward a mortgage adds to the equity that you have in your property as an investment.

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