What is an asset, and what is a liability?


What is an asset? What is a liability?

Most commonly, an “asset” is defined as something you own that has value.  Accountants and banks consider property such as your house, contents, car, boat, caravan etc. as assets.

A “liability” is effectively the opposite of an asset.  A liability is something that costs you money – something you owe.  e.g. a debt (home loan, personal loan, credit card, hire purchase, student loan, etc.)

When you apply for a loan with a bank, they will ask you to list your assets and your liabilities on the application form.  Many people list their cars and their household effects on this form and feel that they are quite well-off.  In reality, cars and personal effects depreciate (lose value) very quickly as they are used and worn out.

Those who aspire to be financially free use a different definition of “assets” and “liabilities”.

In Robert Kiyosaki‘s book ‘Rich Dad, Poor Dad’, an asset is defined as something that puts money in your pocket, and a liability is anything that costs you money.  This is a very straightforward definition and one worth thinking about.

Using Kiyosaki’s definition, is the house you live in, or the car you drive, an asset or a liability?

The house you live in costs you money (loan costs, rates, insurance, maintenance), so by Kiyosaki’s definition it is a liability, not an asset.

I’m not saying that it is bad to buy a house to live in, just that it should not be considered an asset for investment purposes.  It is good to own a home because over time property tends to increase in value, and owning means you are not wasting money on rent.

Ponder this scenario..

Option 1: Spend $600,000 on a house to live in (approximate price of the “average” house in Auckland, New Zealand)

  • You have saved really hard and have $120,000 as deposit (20% of purchase price).
  • You borrow the other $480,000 from the bank at a very low rate of 6.00% (rates are historically low at present)
  • From your hard-earned wages, you pay $2878 per month in home loan payments (over 30 years, with interest rates likely to rise)

Option 2: Spend $400,000 on a house in a less salubrious suburb with a smaller yard.

  • Put down your $120,000 deposit
  • Borrow $280,000 at 6.00%
  • From your hard-earned wages, you pay $1679 per month in home loan payments.

You will have this “liability” for a long time, so consider how the payments will impact on your lifestyle.

Also, you will have 30% equity in the $400,000 purchase.  This can be used towards a deposit on an investment property!

Check back in a few days for my next post which explains how to use equity in your home to purchase an additional property.

 

 

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