A lot of people have misconceptions regarding assets and liabilities, thinking that it’s confusing to define and differentiate the two. But the truth is, you don’t need to be good in numbers or be a degreed accountant to know the difference.
See, it all boils down to this fact: An asset puts money in your pocket and a liability takes money out of your pocket. No exceptions, it’s not rocket science.
Most people consider their house as their biggest asset. The reality however, is that a house is actually one of the biggest liabilities that you can have. I know a lot of people might disagree with me on this one, and I’d like to offer my arguments to support this:
1. “A house will always increase in value in the future.”
While it’s true that real estate does appreciate, it is not a definite possibility. A lot of people learned this the hard way during the real estate crash in 2006 where millions of homes lost their value and went into foreclosure.
2. “Owning a house in the American dream”
Yes owning a house is the American dream. However, you should only seize that dream when you’re ready to do so. And by that I mean you need to be financially healthy enough.
Being financially healthy doesn’t just equate to the individual being able to afford the mortgage payments. Rather, it means that an individual can afford the mortgage payments no matter what happens–whether it’s job loss, an accident or illness. Enough cash flow from investments should be able to cover the mortgage.
3. “I can pay cash on a house.”
Not a lot of people can afford to pay cash on a house. And even if an individual could afford it, the principle still applies that an asset puts money in your pocket and a liability takes money out of your pocket. If you have enough cash to pay for the house upfront, you’re actually better off buying assets like rental properties instead.
Let’s say an individual has $300,000 cash to purchase a property. If that person bought an investment property instead, let’s say a 4-plex worth $1,000,000 and puts down 25% down payment (which is about $250,000), they’ll be able to produce a cash flow of $5,000.
Then what they can do is purchases a home with $50,000 down payment, and conservatively the home’s mortgage would only be $2,000. The cash flow ($5000) is more than enough to cover the mortgage payment of $2000 and they would still have $3,000 left.
As you can see in this example, the person who had $300,000 cash decided to spend their money wisely. Instead of buying a liability (home), they chose to buy an asset (investment property).
4. “It’s better to pay for mortgage than waste payments on rent.”
What a lot if people don’t consider is that owning a home is a LOT different from renting. For one, rental properties usually come with a lease of only 1 year. That gives you the flexibility to downgrade to a lower apartment with lower rent if you lose your job or working hours get cut, and upgrade to a better apartment in the event of a job promotion or having a partner move in.
A house on the other hand is a 30-year commitment. On top of that, you can’t just call the landlord if you need to repair a clogged toilet or a leaky roof. Homeowners take care of all the repairs and the costs can pile up quickly. And that doesn’t include the property taxes and in some instances HOA dues, lawn maintenance, etc.
Also remember that when you have your own home you also need to buy your own furniture, and cover the costs of home improvements.
Dive into all that, and before you know it you’re in way over your head.
5. “I can afford the mortgage payment.”
A lot of people think they can afford their mortgage payments. But that truth is, you should only be spending a maximum of 20% of your income on your mortgage. That means if you want to buy a $300K house with 3.5% down and a mortgage payment / PITI of $2,100, you need to have a minimum monthly income of $10,500.
The reason why a lot of people lose their house after a few years is because they never anticipated the expenses involved in owning a property. Just because you can cover your mortgage payment doesn’t mean you’ll be able to easily handle your other bills.
Think about your car payments, utilities, food, student loans, repairs, vacations, groceries etc. And then factor in emergency expenses like hospital bills, traffic tickets, etc. You may realize that the payments that you thought you could easily afford quickly become payments that you could barely make, when you consider all the existing and potential expenses in your life.