So many times have I heard of people who believe they are investing in a car clothing, or even a television. Those items are not investments! They are liabilities.
Assets are items that generate income or appreciation. Liabilities are items that come at a cost to you and do not generate income. Even if you sell your car later you will still likely do so at a loss from your original purchase price.
Your home is generally considered an asset because historically houses appreciate over the years and can be sold at a higher value than you purchased it. However, inflation does play a large part in the true value of a home (or an asset). Inflation is outside the scope of this lesson.
Stop fooling yourself by believing that your toys and gadgets are investments. Yes, they may feel like an investment because they improve your quality of life. Overall if they are not appreciating, they are deducting. Some common consumer liabilities are:
-
Credit card debt: Accumulated balances on credit cards that have not been paid off in full.
-
Student loans: Loans taken out to finance education expenses, typically with a repayment plan after graduation.
-
Mortgages: Loans used to purchase real estate, with the property serving as collateral for the loan.
-
Auto loans: Loans taken out to finance the purchase of a vehicle, with the vehicle serving as collateral.
-
Personal loans: Loans obtained for various personal expenses, such as home improvements, medical bills, or debt consolidation.
-
Payday loans: Short-term loans with high-interest rates are often used by individuals facing immediate financial needs.
-
Medical debt: Unpaid medical bills resulting from healthcare services or treatments.
-
Overdraft fees: Charges incurred when a bank account is overdrawn, typically due to insufficient funds.
-
Utility bills: Unpaid bills for services such as electricity, water, or gas.
-
Tax debt: Unpaid taxes owed to the government, which can result from underpayment or failure to file tax returns.
A Word on Mortgages
While a house is an asset, the mortgage on the house is a liability to the borrower and an asset to the lender. It’s all about where the money is going. As the house appreciates over time, the difference between the value of the property and the amount owed in the mortgage is called equity. The homeowner can borrow against the equity (appreciated value) in the home for a variety of reasons. However, if the borrowed money is not put into something that will boost the value of the home or into an asset, it also becomes a liability.
Credit card debt is a common liability among consumers which we will explore in Module 3.