Module 2 Credit – Personal Finance
70/20/10 Rule
This general "rule of thumb" helps you understand how much credit you can afford. Credit
cards are loans, so avoid borrowing more than 20 percent of your annual net income on all
of your loans (not including a mortgage/rent). Payments on loans shouldn't exceed 10
percent of your monthly net income.
Rule #1 – 70% of your income goes to living expenses such as rent, mortgage, food, gas,
utilities, insurance premiums, etc. – monthly living expenses
Rule #2 – 20% - Your total outstanding debt should not exceed 20% of your annual net income.
Rule #3 – 10% - Your monthly loan payments should not exceed 10% of your monthly net
income.
Examples:
Never borrow more than 20% of your yearly net income
•
If you earn $400 a month after taxes, then your net income in one year is:
12 x $400 = $4,800
•
Calculate 20% of your annual net income to find your safe debt load.
$4,800 x 20% = $960
•
So, you should never have more than $960 of debt outstanding.
•
Note: Housing debt (i.e. mortgage payments) should not be counted as part of the
20%, but other debt should be included, such as car loans, student loans and credit
cards.
Monthly payments shouldn’t exceed 10% of your monthly net income
•
If your take-home pay is $400 a month:
$400 x 10% = $40
•
Your total monthly debt payments shouldn’t total more than $40 per month.
•
Note: Housing payments (i.e. mortgage payments) should not be counted as part of
the 10%, but other debt should be included, such as car loans, student loans and credit
cards.
Example Calculations:
1. Jeff has a monthly net income of $4700. His fixed monthly expenses consist of a rent
payment of $700. He is also paying off a student loan of $100 per month and a car
payment of $350 per month. Jeff wants to buy a new snowmobile using a credit card.
What is the largest monthly payment Jeff can afford for the snowmobile so that his
credit card payment, student loan, and car payment keep him within a safe debt load
of 10%?
2. Doug and Julie have a combined monthly net income of $5,000. Their fixed monthly
expenses consist of a $2000 mortgage payment. They also have an outstanding student
loan balance of $10,000 and a balance of $2,500 for a family trip that they put on
their credit card last month.
How much more outstanding debt can they take on and still be within a safe debt load
of 20%?
3. Jack has a monthly net income of $2600. His expenses include a $550 mortgage, $150
student loan payment, $75 auto insurance payment, $90 food expense, and $25 credit
card payment. What is the largest monthly payment Jack could afford to take on in
more debt if needed?
4.
Mackenzie makes $55,000 per year for annual net income. What are the largest
monthly loan payments she should have? How much outstanding debt should
Mackenzie have to stay within a safe debt load?
5.
Riley makes $200 per week in net pay. What is the maximum of monthly loan
payments she should have? How much outstanding debt should Riley have to stay
within a safe debt load?