We’re quickly nearing the end of 2022 — a year that has featured quite a few ups and downs for people across the United States. Prices at the pump have oscillated from affordable to wildly expensive, the federal interest rate has increased, groceries are costing more, and nearly 64% of Americans are living paycheck to paycheck.

Time to panic, right? Wrong!

Look, the economy can cause us all to feel a little unnerved, but there’s never been a better time to lock in a budget, plan ahead, and find ways to improve your financial health. If you’re looking for a bona fide way to manage your expenses, take a look at what the 10/20 rule can do for you. 

What is the 10/20 rule?

While it’s technically a rule of thumb as opposed to an enforceable decree, the 10/20 rule is a system of budgeting that can work for virtually anyone. The idea is to keep your total debt at or under 20% of your annual income, while maintaining monthly payments at no more than 10% of your monthly net income. 

Very important — these figures exclude real estate debt. Don’t factor in your FedLoan or mortgage payments. 

So what is included? Any other consumer expense. Car payments? Yep. Credit card payments? For sure. Personal loans? Now you’re catching on! If you’re really feeling weighed down by consumer debt and your bank account is feeling the strain, then the 10/20 rule just might be worth considering.

The goal of the 10/20 rule is to take a look at the actual income you’re bringing in and determine the amount of debt you should be carrying. By using your net pay after taxes, you get a more realistic picture of how much you’re earning and how much debt you can really afford.

Here’s an example of the 10/20 rule

Say your salary is $40,000 a year and you’re a resident of the state of Texas. After taxes, you’ll be bringing home $33,900 each year, and your take-home pay will sit around $2,825 per month.

To figure out 20% of your annual income, just divide your income by 5. $33,900 divided by 5 is $6,780. You’ll want to keep your total debt below that. (Remember, your mortgage doesn’t count.)

To figure out 10% of your monthly income, just divide it by 10. $2,825 divided by 10 is $282.50. Try to keep the combined total of your monthly debt payments below that.

If your monthly debt payments are below that number, that’s great! The rest can go toward savings goals or investing.

Does everyone need to follow the 10/20 rule?

The 10/20 rule is a great rule of thumb to refer to when setting a budget, but it’s important to remember that it doesn’t apply equally well to every financial situation. If you have a high balance on your student loan debt, for example, you might owe more than 20% of your annual income — maybe even a lot more — but the payments can still be manageable.

If a 20% debt-to-income ratio isn’t realistic for you, just try to keep your total monthly debt payments below 10% of your monthly earnings after taxes.

When the 10/20 rule can help

Whether you’re trying to build up a nest egg, save for an emergency fund, or stash away for a trip abroad, budgeting is the best way to ensure that you’re meeting your financial obligations while saving for your future. 

The 10/20 rule is a fantastic way to get an idea of how much debt you can take on — or assess the state of your current debt-to-income ratio. If you’re carrying around large amounts of debt, this particular budgeting strategy will help you set a goal for how much you want to be paying on your consumer debts each month. 

If you don’t need every single element of your budget mapped out, the 10/20 rule might be perfect for you. There are plenty of budgeting types out there that allocate every single cent to your expenses — this rule doesn’t. However, if you need a more comprehensive budget or if you struggle with keeping your discretionary spending in check, this particular method might not be your best bet.

The 10/20 rule vs. other types of budgeting

All budgets are created equal, right? Au contraire! While the goal of budgeting might be the same across the board, there are plenty of different ways to get there.

We’ll take a look at how the 10/20 rule compares to a few different popular budgets. The cool thing is that you can combine elements from each to customize your own personal budgeting strategy. Use it to get out of debt, pad your savings account, and take a look at your spending habits.

Building a financial plan? Don’t miss these 7 tips.

The 50/30/20 budget

Popularized by Elizabeth Warren in her book, All Your Worth: The Ultimate Lifetime Money Plan, this budgeting rule involves putting 50% of your after-tax income into mandatory living expenses or needs, 30% into wants, and 20% toward savings and debt repayment. This is particularly helpful for those who need to break their spending down into categories — it’s a bit more comprehensive than the 10/20 rule. 

Envelope budgeting

Traditionally, the envelope budget consisted of labeling envelopes for each monthly expense, setting money aside in each individual envelope, and using these to pay each bill each month. 

While we don’t recommend leaving all your income in envelopes full of cash around the house, you can still implement this strategy digitally. In fact, that’s exactly how Simplifi works, setting aside money for all your bills in virtual “envelopes” each month, automatically.

Zero-based budgeting

The zero-based budgeting method wants you to spend every cent you earn. 

Wait — what?

You read that right. With zero-based budgeting, every cent of your income is allocated to paying your bills, debt repayment, and savings. With this particular budget, your goal is that each month, your income minus your expenses, debt repayment, and savings equals zero. 

This strategy is super beneficial for those who require a very comprehensive budget where every single expense is accounted for. 

How the 10/20 rule is different

Each budgeting method is meant to push you into a better financial position, but each has its own strengths and weaknesses. 

The 10/20 rule is very debt-focused. It’s extremely helpful if you’re trying to navigate your way out of high-interest credit card debt or excessive consumer debt. It’s simple, and it isn’t prescriptive about what you’re doing with the rest of your money. 

If you’re focused on paying down debt as a financial goal, the 10/20 rule can help you make good decisions about things like credit card debt or a new car loan.

Does your budget stack up? See what the average American spends on these 20 common monthly expenses.

Do lenders look at the 10/20 rule? Nope!

Do you have a big purchase on the horizon? Have you been starting to position yourself for the best possible loan and rate that you can get? If so, maybe you’re wondering whether lenders care about the 10/20 rule. The answer? Nope!

The good news — lenders don’t use a 10/20 rule. You don’t need to worry about them checking on your 10/20 ratios when looking for things like a loan or credit card. Lenders do, however, look at things like your debt-to-income ratio when determining your loan eligibility, the amount you can borrow, and what your interest rate will be.

If you’re looking to put yourself in a good position when it comes to financing, sticking to the 10/20 rule will help you get your debt-to-income ratio in a good place. That helps you maximize your eligibility for loans and can steer you away from steep interest rates. 

The lower your outstanding balances are, the better chance you’ll have of being able to borrow money when you need it — often, at much better rates. 

Want to get out of debt for good? Our guide to living a debt-free life is a great starting point. 

Keep an eye on your debt-to-income ratio

The 10/20 rule is an excellent way to optimize your debt-to-income ratio, work your way out of high-interest debt, and stop giving money away to credit card companies and lenders. 

By keeping your monthly debt payments below 10% of your monthly income and your total consumer debt below 20% of your annual income, you can start to put yourself in a better financial position and plan for a brighter future.