What Is the 20/10 Rule of Thumb? - Experian (2024)

In this article:

  • What Is the 20/10 Rule?
  • When Does the 20/10 Rule Not Apply?
  • Pros and Cons of the 20/10 Rule
  • 20/10 Rule of Thumb vs. 70/20/10 Rule of Thumb

The 20/10 rule of thumb is a budgeting technique that can be an effective way to keep your debt under control. It says your total debt shouldn't equal more than 20% of your annual income, and that your monthly debt payments shouldn't be more than 10% of your monthly income.

While the 20/10 rule can be a useful way to make conscious decisions about borrowing, it's not necessarily a useful approach to debt for everyone. Here's what you need to know about how the 20/10 rule works, the pros and cons and other ways to think about debt management.

What Is the 20/10 Rule?

The 20/10 rule uses your income as a guide to limit your debt. You can think of it as a system for how you can avoid building up so much debt that it becomes a burden, or as a goal to aim for if your debt is already too much.

This rule of thumb applies to different types of debt obligations, including credit card payments and installment payments toward personal loans, dental or veterinary payment plans, payday loans, BNPL plans, auto loans and student loans. The 20/10 rule does not consider mortgage costs or other housing expenses (more on that later).

By setting a self-imposed limit on your total debt of 20% of your yearly net pay and a limit on your monthly debt obligations of 10% of your monthly net pay, you may be more inclined to think twice before taking on more debt.

Example of How to Use the 20/10 Rule

To use the 20/10 rule, start by looking at your monthly take-home pay—that's your pay after taxes are taken out. You can find it by looking at the pay stubs you receive from your employer, the dollar amount on your paycheck or the amount of your direct deposits.

For this example, consider Tom, a hypothetical borrower who has a take-home pay of $50,000 per year. In this example, 20% of Tom's $50,000 income is $10,000. According to the 20/10 rule, Tom's total debt should fall below $10,000.

Dividing Tom's annual income into 12 months, we see that his take-home pay is about $4,167 a month. Using the 20/10 rule, Tom should keep his monthly debt obligations below 10% of that number, which equals about $417 a month.

When Does the 20/10 Rule Not Apply?

When using the 20/10 rule of thumb, don't include mortgage or monthly rental payments. Instead, include your monthly housing payments in your monthly expenses category of your budget.

In general, the 20/10 rule may not apply well for everyone's personal financial situation. For instance, you don't necessarily need this rule of thumb to decide whether you're strained by your debts. You might determine your debt levels are manageable simply because your monthly payments are affordable, and you aren't revolving high-interest debt from one month to the next.

Pros and Cons of the 20/10 Rule

The 20/10 rule can be a great way to keep debt tenable and avoid financial strain, but it also has certain downsides to keep in mind. Consider the following before you incorporate this rule into your budgeting strategy.

Benefits of the 20/10 Rule

  • It helps you limit debt. The biggest benefit of the 20/10 rule is that it helps you mind how much you're borrowing to avoid too much debt. It's in your favor to be cautious about taking on new debts, and the 20/10 rule can be a useful framework for guiding your decisions.
  • It can help you come up with a repayment goal. If you're currently grappling with high balances and want to chart a course out of debt, you can use the 20/10 rule to set a goal. For instance, say you have an $8,000 auto loan balance and $2,000 in credit card debt with an annual net income of $35,000. You could use the 20/10 rule to set a goal for yourself to reduce your debts to $7,000 (20% of $35,000). That means you have to pay off $3,000 in debt to meet your goal.
  • With less debt, you'll have room to grow financially. By keeping debt in check, you can focus on growing wealth through saving and investing. You can also limit debt-related stress and enjoy more financial freedom by keeping overheard down.

Downsides of the 20/10 Rule

  • It doesn't always apply. The 20/10 rule considers mortgage debt as a monthly expense, rather than debt. And beyond that, many people may carry other types of debt that would put them over the rule. If you have high student loan payments, for example, the 20/10 rule may not be the right gauge for your financial health.
  • Lenders don't use the 20/10 rule. Lenders look at how much debt you're carrying in relation to income to determine whether you're likely to struggle to meet your monthly financial obligations. But they use a different metric: your debt-to-income ratio (DTI). To find your DTI, add up your monthly payments due and divide by your monthly gross pay. Lenders tend to look for a DTI below 43%, and that includes mortgage payments.
  • Credit cards can complicate matters. Credit cards have minimum payments, which is the dollar amount card issuers require you to pay every month. By only making your minimum credit card payment in order to stick to the 20/10 rule, your credit card balances may balloon to unmanageable levels. Have a plan to pay off your credit cards as quickly as possible to avoid interest charges.

20/10 Rule of Thumb vs. 70/20/10 Rule of Thumb

The 20/10 rule of thumb is a guideline for handling debt, but it doesn't provide you with a complete blueprint for how you should be budgeting your money. On the other hand, the 70/20/10 rule is a budgeting plan that you can use alongside this debt management technique to manage your income.

According to the 70/20/10 rule, you should:

  • Allocate 70% of your take-home pay toward all of your expenses and discretionary spending, including your housing payment, bills, groceries, transportation and any retail, dining, entertainment or other spending you do.
  • Allocate 20% of your take-home pay toward your savings and investment accounts, including your emergency fund and any sinking funds you use for other savings goals.
  • Allocate no more than 10% of your take home pay toward debt management.

For example, say you have a monthly after-tax salary of $4,000. You would allocate $2,800 toward all of your expenses and spending, $800 toward savings and $400 toward debt. This may or may not work for you depending on how much debt you have and how quickly you're trying to pay it off.

As you solidify your budget, it's important to keep experimenting until you find a method that works for you and your goals. If you find yourself having trouble sticking to your budget, you might want to rethink your approach.

The Bottom Line

Using a debt management rule of thumb such as the 20/10 rule can help you keep your feet on firm financial ground by avoiding going into too much debt. That's of major importance because—alongside budgeting, saving and investing for retirement—a healthy relationship with debt will help you become or stay financially secure.

In addition to being strategic in how much you borrow, keep an eye on your credit. Check your credit report and credit score for free through Experian to see how the amount of debt you carry and your history of monthly payments are impacting your credit. You can also sign up for free credit monitoring for alerts to changes in credit usage or any new activity listed on your credit report.

What Is the 20/10 Rule of Thumb? - Experian (2024)

FAQs

What Is the 20/10 Rule of Thumb? - Experian? ›

The 20/10 rule of thumb is a budgeting technique that can be an effective way to keep your debt under control. It says your total debt shouldn't equal more than 20% of your annual income, and that your monthly debt payments shouldn't be more than 10% of your monthly income.

What is the 20/10 rule for credit? ›

The 20/10 rule follows the logic that no more than 20% of your annual net income should be spent on consumer debt and no more than 10% of your monthly net income should be used to pay debt repayments.

What is the 20/10 rule of thumb? ›

The 20/10 rule of thumb limits consumer debt payments to no more than 20% of your annual take-home income and no more than 10% of your monthly take-home income. This guideline can help you limit the amount of debt you carry, which is important for your financial health and your credit score.

Why do financial advisors recommend the use of the 20 10 rule? ›

Pros and Cons of the 20/10 Rule

Whether you're planning for a car loan or creating a debt payoff plan, the 20/10 rule's ability to guide your debt decisions ahead of time is its most significant advantage. The more consumer debt you have, the harder it is to meet your other financial goals.

Which type of debt is excluded from the 20 10 rule calculation? ›

What's not included in the 20/10 rule? Because the 20/10 rule applies to consumer debt, your mortgage and student loans usually aren't included. These types of “good” debt aren't usually considered consumer debt. However, you should review your budget to limit other types of debt as well.

What are the 3 C's of credit? ›

Character, capital (or collateral), and capacity make up the three C's of credit. Credit history, sufficient finances for repayment, and collateral are all factors in establishing credit. A person's character is based on their ability to pay their bills on time, which includes their past payments.

What is the 20 10 rule and give an example? ›

It says your total debt shouldn't equal more than 20% of your annual income, and that your monthly debt payments shouldn't be more than 10% of your monthly income. While the 20/10 rule can be a useful way to make conscious decisions about borrowing, it's not necessarily a useful approach to debt for everyone.

What are the 5 C's of credit? ›

Called the five Cs of credit, they include capacity, capital, conditions, character, and collateral. There is no regulatory standard that requires the use of the five Cs of credit, but the majority of lenders review most of this information prior to allowing a borrower to take on debt.

What percentage of your monthly income should go for credit card payments? ›

In general, you never want your minimum credit card payments to exceed 10 percent of your net income. Net income is the amount of income you take home after taxes and other deductions. You use the net income for this ratio because that's the amount of income you have available to spend on bills and other expenses.

How much of my paycheck should go to paying off debt? ›

50% of your net income should go towards living expenses and essentials (Needs), 20% of your net income should go towards debt reduction and savings (Debt Reduction and Savings), and 30% of your net income should go towards discretionary spending (Wants).

What is rule 69 in finance? ›

What is the Rule of 69? The Rule of 69 is used to estimate the amount of time it will take for an investment to double, assuming continuously compounded interest. The calculation is to divide 69 by the rate of return for an investment and then add 0.35 to the result.

What is the rule of thumb for savings by age? ›

By age 35, aim to save one to one-and-a-half times your current salary for retirement. By age 50, that goal is three-and-a-half to six times your salary. By age 60, your retirement savings goal may be six to 11-times your salary. Ranges increase with age to account for a wide variety of incomes and situations.

How much savings should I have at 50? ›

By age 50, you'll want to have around six times your salary saved. If you're behind on saving in your 40s and 50s, aim to pay down your debt to free up funds each month. Also, be sure to take advantage of retirement plans and high-interest savings accounts.

What is a good rule of thumb to limit consumer credit payments to no more than? ›

Correct. A good rule of thumb is to limit consumer credit payments to no more than 20% of your net (after-tax) income.

What is a good savings rate? ›

You should consider saving 10 - 15% of your income for retirement. Sound daunting? Don't worry: your employer match, if you have one, counts. If you save 5% of your income and your boss matches another 5%, you've accomplished a 10% savings rate.

How much money should I be saving? ›

One popular guideline, the 50/30/20 budget, proposes spending 50% of your monthly take-home pay on necessities, 30% on wants and 20% on savings and debt repayment. The necessities bucket includes non-negotiable expenses like utility bills and the monthly minimum payment on any debt you have.

What is the 15 3 rule for credit? ›

You make one payment 15 days before your statement is due and another payment three days before the due date. By doing this, you can lower your overall credit utilization ratio, which can raise your credit score. Keeping a good credit score is important if you want to apply for new credit cards.

Is it better to pay down multiple credit cards or pay off one? ›

Interest Rates: Compare the interest rates on both credit cards. If one card has a significantly higher interest rate, it may be more beneficial to focus on paying off that card first. By eliminating the high-interest debt, you can save money on interest payments in the long run.

What is the 2 90 rule for credit cards? ›

Two Credit Cards Every 90 days

If you apply for two credit cards on the same day, data points suggest one of your applications will be put on hold as an automatic fraud prevention mechanism. There are conflicting reports on how charge cards are counted in this two-card limit.

What is the 5 24 rule credit cards? ›

The 5/24 rule is an unofficial policy that dictates that Chase won't approve you for its cards if you've opened five or more personal credit card accounts from any issuer in the last 24 months. Put simply, the number of cards you've opened in the previous two years will affect your approval odds with Chase.

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