If you’re like me, you’ve likely spent a fair amount of time over the years looking into ways to budget for life’s many surprises. The 10/20 rule, or the 20/10 rule, is a viable option for many people to save for the future, maintain a reliable budget, and even help reach financial milestones.
However, as with all budgeting systems and solutions, the 10/20 isn’t a “one-size-fits-all.” It works well for some households, but won’t necessarily fit all financial needs and expectations.
So what is the 10/20 rule, how does it work, and is it the right budgeting strategy for you?
What does 10/20 mean when budgeting?
I’ve seen two different variants of the rule for budgeting, so let’s discuss both here.
1. Debt Limit – Consumer Debt Below 20% of Income
The first variant of the 10/20 rule, or 20/10 rule, simply means you follow the rule of keeping your non-mortgage debt at or preferably under 20% of your annual income.
Then, ideally, your monthly debt payments expenses should come to no more than 10% of your monthly net income. That may sound strict, but it is important to remember a few factors. As mentioned earlier, this 10% cap excludes mortgage payments for your residence. These are considered to be living expenses and not consumer debt, and therefore do not count in the 10/20 rule.
Technically, you could also exclude other investment related debt-payments, such as mortgage payments on a rental property.
However your other loan payments must be included within this 10% threshold. This would include car payments, credit card expenses, buy-now-pay-later bills, etc.
Finally, you have 90% of your income free to save and spend as per your needs. So to summarize here:
- The total amount of your consumer debt is limited to 20% of your annual income.
- You monthly consumer debt payments are limited to 10% of your monthly income.
- The remaining 90% of your income is used for your life’s needs (mortgage payments, rent, etc.), other spending, and savings.
2. Savings Target – 20% of Income Goes to Savings
In this variation of the rule, an explicit target is set on the savings goal. You first set aside 20% of your income for savings. You then use 10% of your income to make your consumer debt payments. The balance 70% of your income is free to use as per your needs.
Summarizing this in a list format:
- 20% of your income goes to savings first
- 10% of your income goes to paying off consumer debt
- 70% available to spend on mortgage/rent and other spending needs.
Unlike the debt-focused variation mentioned above, there’s no explicit limit on the total amount of debt. While yes there is a limit on monthly debt payments, you could be using that money to pay down a 48-month loan at 6% interest, or you could be using that to pay an 84-month loan at 12% interest. There’s a big difference!
What are the Pros and Cons of 10/20 Rule?
As with any budgeting rule, the main idea is to provide a framework for planning how your hard earned money is allocated and spent. I like to think of it as a rough mental model and then tailor the rules towards what works best for my situation.
The 10/20 rule can be a manageable way to continue saving money while paying off debts and enjoying your income. It’s suitable for people making a healthy regular income but who may have previously struggled to put any money aside.
What I really like about the 10/20 rule (or 20/10 rule) is that you don’t have to sacrifice too much to take part. That said, it’s not the best budgeting fit for everybody.
If you are paying back significant loans and do not have a salary capable of covering those debts – as much as you would like to put into savings – then you might not be able to follow the 10/20 rule.
You will instead need to put more of your savings into covering your debt before looking to any other financial goals in the short term.
Your main goal should always be to cover what you owe first, especially if demands from banks or creditors are increasing. And, while you may have plans for your money, plans that the 10/20 rule could help with, focus on settling your debts before prioritizing your savings.
Which Version of the 10/20 Rule is Better?
Both variants have their advantages and disadvantages and will apply to different situations. The key difference that stands out to me is that Version 1 (debt limited) forces you to limit the amount of consumer debt that you are carrying. This is great for people who need a framework for thinking about how to control their debt load.
The second version (savings target) is great for people that have no or very little consumer debt, as that frees them up to focus on savings and building up a nest egg.
Each person or family that decides to use the rule must decide what works best for their situation. If your debt is out of control – use the first version as a guide post to help you bring your total debt under control. With some aggressive debt pay-down, get your total debt to threshold of 10% of your total income.
If you are relatively debt-free, use the second version to grow and invest your savings.
Is 10/20 always guaranteed to work?
Provided the rule is used with the right intent and the right spirit, I think the rule does work for its intended purpose.
How do I use the 10/20 rule?
As complicated as it may sound, it can actually be pretty easy to follow the 10/20 rule.
Start by taking your income after tax. Now, multiply that number by 20% and then 10% respectively.
Now, you only need to put 20% of that money into your savings and 10% towards your consumer debt. As mentioned above, that includes your credit card debt, car payments, loans, and medical payments.
While it may not be the fastest way of saving money (see FIRE savings models if you’re really keen to start saving cash fast), it’s a popular way to save money while still paying for everyday expenses.
What are some alternatives to 10/20 budgeting?
As mentioned above, the 10/20 rule isn’t for everyone. So, what are some alternatives to the rule?
The zero-based budgeting method works on the idea that you spend everything you earn. Everything you earn goes straight towards your standard living bills and debt repayments.
Anything left over can go into savings, but that’s it! It is a very strict strategy and perfect for those who need to focus on their debts and get by before prioritizing savings and financial adventures!
The 50/30/20 rule works by putting 50% of your income after tax into your living expenses. Then, 30% of it goes into your wants (holidays, entertainment, gym memberships, etc.). And finally, the last 20% goes into your debt repayment.
Finally, envelope budgeting does exactly what it suggests. It’s all about putting money in physical envelopes!
You take multiple envelopes and mark them each with their intended purpose, i.e., each monthly expense. You then put the necessary money per expense in each envelope and use them to cover your monthly costs.
You can even do this digitally by using apps instead of having all of your income in cash in one place!
Will following 10/20 affect my standing with lenders?
No, using the 10/20 rule will not affect your standing with lenders. Lenders do not check on your 10/20 ratios and will not consider them when looking into your financial history.
However, they will look at your level of debt, especially with regard to your income. So, if you’re trying to make your finances look better for lenders, following a budgeting strategy such as the 10/20 rule (if you can) is a great place to start!
by Jon Craig
I am the creator of Project Financially Free and I started this journey to both educate myself and share my insights on personal finance. I’m passionate about financial literacy and I invite you to join me on this transformative path. See more.