20/10 Rule Finance – Definition , Purpose And More?

20/10 RULE WHAT IS It ?

First, the 20/10 rule is a conservative rule of thumb for other consumer loans, not counting a home payment. What does that mean exactly? This means that the household’s total debt (excluding housing payments) must not exceed 20% of the household’s net income. (Your net revenue is the amount you actually “take home” after taxes in your paycheck.) Ideally, monthly payments should not exceed 10% of the net amount you bring home.

For example, if you bring home $60,000 per year, your total consumer debt should not exceed $12,000 and total monthly payments should not exceed $500 per month.

What Is The Purpose Of The 20/10 Rule?

The goal of the 20/10 rule of thumb is to control your debt (less mortgage payments) in relation to your annual and monthly take-home pay. In other words, it’s designed to help you avoid taking on more debt than you can afford.

For the 20% portion of the equation, you need to calculate whether your consumer debt (credit cards, car loans, student loans, etc.) exceeds 20% of your annual after-tax income.

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Is The 20/10 Rules Realistic?

It’s a great benchmark, but it doesn’t necessarily work for everyone. Perhaps you came to this concept later in life and are now wondering if it’s too late. It’s never too late-night to start your journey to financial health. The rule of thumb tends to assume you’re already in good financial shape, but that’s not realistic for many people.

For example, the model may seem particularly problematic for those with student loan debt. Let’s say you got a job fresh out of college and an annual after-tax income of $30,000. You owe $5,000 on your car and you have a $1,000 credit card balance.

According to the 20/10 rule, at 20% of the point, you are in great shape. Then six months later, $20,000 in student loans come due and suddenly the model explodes. You are now about 86% in debt. oops! All you can do is try to effort on paying off that debt before you borrow more.