What is the 20/10 rule?

Quick insights

• The 20/10 rule is a financial strategy that advises setting limits on both long-term and short-term debt.
• According to the 20/10 rule, you should avoid using more than 20% of your annual income toward paying off debt (aside from housing) and avoid spending more than 10% of your monthly take-home income on debt payments.
• While not for everyone, strategies like the 20/10 rule can help you make and keep a budget.

How the 20/10 rule works

The 20/10 rule is a financial strategy to help you avoid dangerous levels of debt. Simply put, the 20/10 rule advises that you should avoid accumulating long-term debt that exceeds 20% of your annual income, and you should avoid debt payments of more than 10% of your monthly income.

Benefits of using the 20/10 rule for budgeting

The 20/10 rule can be very helpful in managing your debts and monthly budget. It could be especially helpful in the following ways:

• The 20/10 rule can help you set and meet goals for paying down debt.
• The 20/10 rule may help improve your credit score by budgeting responsibly, making on-time payments, and reducing your credit utilization ratio. It is generally recommended to use no more than 30% of your available credit at any given time.
• Setting concrete guidelines for managing your finances, like the 20/10 rule, can help you reduce financial stress while saving for the future.

Potential cons of using the 20/10 rule for budgeting

The 20/10 rule can help you manage most major debts and expenses, such as credit card and auto loan payments, but there are some situations where the rule doesn’t apply.

• Housing: The 20/10 rule does not include mortgage, rent, or other housing payments.
• Student loans: While student loans are typically included in the 20/10 rule, this payment planning method might not be helpful to people with large monthly student loan payments.
• Applying for credit: Lenders use DTI – debt-to-income ratio – rather than the 20/10 rule when making credit decisions. You can easily calculate your DTI by taking your total monthly expenses, including housing and student loans, and dividing by total monthly income.  Lenders usually want to see a DTI at or below 43%.
• Credit card debt: While paying less than your full monthly credit card balance can help you meet the 20/10 rule, it might lead to accruing  interest and carrying large balances from month to month, which can be harmful to your credit score and overall financial health.

Three debt-reduction methods

The 20/10 rule could be a useful way to approach financial planning, but there are other strategies that can help you stick to a budget and pay down your debt.

• Snowball method: The debt snowball method is a strategy for paying off outstanding debts that emphasizes tackling the smallest debts first and making lower payments on larger debts – even as low as the monthly minimum – as you pay them off one at a time. This strategy can help you build confidence and achieve goals by breaking your total debt into more manageable pieces.
• Snowflake method: The debt snowflake method refers to a strategy of looking for little victories and identifying small but effective methods to start paying off your debt that can accumulate into larger results over time. For instance, putting aside a few dollars from every paycheck to put toward debts or strategically utilizing the rewards that come with your credit cards are small steps that can ultimately net you big savings.
• Avalanche method: The debt avalanche method is geared toward tackling the biggest problems first – in this case, the debts with the highest interest rates – and only paying the monthly minimum on your other debts; once the first debt is completely paid off, you can move on to the next highest from there, and so on. This strategy might result in the greatest long-term savings among the three debt reduction methods, due to the reduction of interest payments over time; even a relatively small debt at a high interest rate can wind up costing you more in the long run than a larger debt at a low interest rate.

More tips for budgeting and reducing debt

Here are some other suggestions to help your budgeting and finances:

• Debt consolidation and balance transfer: Debt consolidation refers to combining two or more outstanding debts into one. This can make it easier to keep track and pay off your debts, and if you consolidate your debt at a lower interest rate it can also net you significant long-term savings.  One method for doing so is a balance transfer, whereby you move debt from one or more credit cards to another, typically one with balance transfer fees and a lower interest rate.
• Credit utilization: Credit utilization ratio is one of the most important factors in determining your credit score. By keeping your credit utilization at or below 30% of your total available credit, you can work to improve your credit score and overall financial wellness.
• Financial health tools: Enrolling in free financial health resources like Chase Credit Journey^® can help you to make and achieve your financial goals as well as providing useful tools like credit score monitoring and data breach notifications.

Bottom line

The 20/10 rule is one of several strategies to help you prioritize budgeting and debt reduction. While the 20/10 rule might not be the best fit for your personal situation, budgeting strategies can be a useful tool for achieving financial well-being.