What is the 20/10 Rule?
To begin, the 20/10 rule is a conservative rule of thumb for other consumer credit , not counting a house payment. What does this mean exactly? This means that total household debt (not including house payments) shouldn’t exceed 20% of your net household income. (Your net income is how much you actually “bring home” after taxes in your paycheck.) Ideally, monthly payments shouldn’t exceed 10% of the NET amount you bring home.
What's The Purpose For The 20/10 Rule?
The main purpose that this rule holds is to help you create a guided structure on how much debt you should actually be carrying. Not only that but this rule also helps you visually see how much you are spending and where you're spending it, which then allows you to clearly set your financial goals for however long you choose to use this rule.
There are instances where this rule may not work for everyone right away. It all depends on how far into debt you are in and if that debt has reflected negatively onto your credit score. It is important that when planning to use the 20/10 rule, you speak with a professional that can help you with any questions regarding how you can pay off your debt as well as repair your credit to get better rates when trying to pay off the debt itself.
How to Use the 20/10 Rule
This rule is a lot more simple to use than you think. With the 20/10 rule there are only 2 things that need to be calculated.
To begin, you will need to start off by knowing what your monthly income is after tax is taken out. (This is the amount that will appear on your direct deposits or in on your checks).
First Calculation (10%)
After you find out your monthly income, you will need to multiply it by 10%.
The reason we are multiplying your income by 10% is because that is how much you should actually be spending per month on your debt payments.
Let's say that you make $3,000 per month:
$3,000 x 0.10= 300
You should at most be making payments of $300 every month on your debt payments.
Second Calculation (20%)
First you are going to multiply your monthly income after tax by 12 to get your yearly income, then multiply that answer by 20%.
This calculation will allow you to see how much you should be spending on debt payments in a year.
So...
($3,000x 12) x .20 = $7,200
That's right... you should only be spending $7,200 every year on debt payments if you make a monthly income of $3,000. Of course, everyone gets paid differently so these calculations can vary depending on the person.
Conclusion
In summary, the purpose of the 20/10 rule is to show you that you should be limiting your total household debt to 20% of net income and monthly payments to 10%. Using this financial approach will help you visualize and manage your spending which in turn will allow you to set better financial goals. While this may not be an immediate fit for everyone, it can pave the way to looking at things differently and it can show you that there are great ways to manage debt.
Try these calculations out and see how it works out for you!
For more questions about the 20/10 rule, feel free to contact us!
