The 20/10 Rule & How It Helps With Debt Management

The 20/10 rule says, 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.
A stressed out woman is sitting in front of her computer and looking at a bill while she tries debt management
Edited by:
Kristin Marino verified

When trying to figure out how to tackle debt, it can feel challenging to get a handle on how much to carry and determine when you’re moving into a zone that’s financially dangerous.

One way to evaluate your debt is to use the 20/10 rule. Here’s how the 20/10 rule works and how it can help you with debt reduction.

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What Is the 20/10 Debt Management Rule of Thumb?

The 20/10 rule of thumb is designed to give you a rough idea of how much of your take-home pay can be “safely” spent to service consumer debt payments.

While it’s best to limit debt as much as possible, for some households completely existing without debt isn’t practical. With the 20/10 rule, you can perform a gut check to determine if you have too much debt for your household income and if you need to use debt reduction measures to move your budget into more stable territory.

The 20/10 rule of thumb is based on consumer debt. In general, this refers to debt used for consumer products. For example, a personal loan or a credit card are considered consumer debt. Your mortgage and student loans are usually not considered in the calculation of the 20/10 rule.

How Does the 20/10 Rule Work?

With the 20/10 rule, you look at your debt using two measures, debt as part of your annual income and debt servicing as a part of your monthly income:

Annual income

The first part suggests that your total consumer debt should account for no more than 20% of your net income (your income after taxes and other deductions). So, if your take-home pay is $40,000 per year, your total consumer debt shouldn’t amount to more than $8,000.

Monthly income

For the second part of this rule, you consider your monthly income. The 20/10 rule suggests that your total debt servicing should not exceed 10% of your monthly take-home income. So, using our example above, if your monthly net income is $3,333.33, then your monthly debt payments should be no more than $333.33 per month.

If you look at your numbers and your debt exceeds these amounts, then there’s a good chance that you’re moving into shaky financial territory. You might need to create a debt reduction plan, which could include debt consolidation, to bring the numbers more in line with what’s affordable for you.

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How to Work the 20/10 Plan for Your Debt Management

When working the 20/10 plan, the idea is to use it as a debt reduction tool to make sure your debt doesn’t become overwhelming.

Limit how much new debt you bring on

First of all, if your debt exceeds the 20/10 rule of thumb, you need to stop bringing on new debt.

If your total consumer debt amounts to more than 20% of your annual take-home pay, it’s an indication that you might have a high debt ratio that could cause problems with your budget later. Additionally, when your debt payments are more than 10% of your monthly take-home pay, that could be a sign that too much of your income is going toward servicing that debt.

If you find yourself in this position, review your financial situation to determine why you have that amount of consumer debt and then look for ways to avoid getting deeper into debt.

Use debt consolidation

Another strategy to manage your debt is to use debt consolidation. With debt consolidation, you use one loan to pay off your other debts. Debt consolidation won’t reduce your total debt amount, but you can end up with smaller monthly payments.

The point of debt consolidation is to get everything in one personal loan, potentially at a lower interest rate. Additionally, the loan term can often be spread out so that your monthly payments are lower. With the combination of a lower interest rate and longer term, you could bring your monthly payment to below 10% of your take-home pay. This makes your debt more manageable and gives you breathing room to implement a debt reduction plan.

Create a debt management and reduction plan

Once you have a debt consolidation personal loan, consider creating a debt reduction plan. Look at how much you can put toward reducing your debt each month. Make extra payments — up to that 10% of monthly take-home pay — so that you get rid of debt faster. When combined with a budget that doesn’t contribute to more debt, this can be an effective way to get your debt under control for the long run.

Look for ways to increase your income

Another way to use the 20/10 rule is to find ways to increase your income. When you have more money coming in, that changes your numbers. Using the earlier example, if you can boost your income by $700 per month, that gives you wiggle room for monthly debt payments of $70 more. That can help you with debt reduction or it can help you with management. Either way, you have the opportunity to create more room in your budget.

Some ways to increase your income include:

  • Start a side hustle
  • Sell items you no longer need
  • Get a part-time job
  • Ask for a raise at work
  • Switch jobs to a new career that pays more

You can also use a strategy like selling items or using a windfall from a bonus or tax return to pay down your principal. This can reduce your total debt owed, as well as reduce your required monthly payments.

Pros and Cons of the Debt Management 20/10 Rule

While it’s always a good idea to find ways to help you manage and minimize debt, the 20/10 rule may work better for some people than others. There are pros and cons to this rule of thumb, and knowing both can help you decide if this is the right debt management method for you.

Frequently Asked Questions

Can I save money while using the 20/10 rule?

Yes, you can save money while you use the 20/10 rule. In fact, you can still save between 10% and 15% of your income as you use the 10/10 rule to help you manage your debt or engage in debt reduction.

Can debt consolidation help with the 20/10 rule?

Yes, with debt consolidation you can potentially lower your monthly payments to bring them in line with the 10% portion of the 20/10 rule. This might also help you with debt reduction.

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 should I do if my debt exceeds the 20/10 rule?

If your debt goes beyond the 20/10 rule, you can improve your situation by addressing your situation. Consider creating a debt reduction plan that includes debt consolidation with a personal loan. You can actually look for ways to increase your income as a way to reduce your and bring your budget in line with your goals.