Blog Post #2 – Asset vs. Liability

– Asset vs. Liability

Assets and Liabilities can be broken down into very simple terms but are some of the most controversial things in personal finance. Reading Rich Dad Poor Dad, helped change my mind to what I should be investing in and what my mindset should be. 

An asset is something that puts money into your pocket every month.

A Liability is something that takes money out of your pocket every month.

It’s actually that simple. And by sticking to this, it will help direct your future financial decisions in a more positive way, help you get out of debt, and guide you to financial freedom.

So why do people have a hard time understanding this? Here’s an example:

Say you buy a $200,000 house that costs $1,200 each month after you put down $10,000 as a down payment. This would be considered a Liability because it is taking $1,200 a month out of your pocket to pay down your mortgage. You would only have $10,000 worth of equity in the property as well. This means that you have $190,000 worth of debt.This is considered bad debt. 

Most people get confused because they bought the house at $200,000 and think that they own all of that cash. You may live in the house but you don’t own it. If you don’t make your payments every month, the bank will let you know who owns it through a foreclosure. Your equity in the house is what you own.

This makes more sense by asking someone the question of how they can spend their equity. Can they use it to go out to dinner? For a vacation? For groceries? No, they can’t. They are paying the loan to the bank every month and not the ones being paid. Your house does not become an asset even after you pay off the entire mortgage because it is still taking money out of your pocket every month for bills, insurance, and utilities.

The only way your house can become an asset is when it is putting money into your pocket. This happens when the income is greater than the expenses. Renting out the house for $1,300 when your mortgage is $1,200 would make the house become an asset because it is paying you every month as well as covering all of the expenses. And this positive difference is called “Cash Flow.”

The Cash Flow is the difference in making your house an asset or a liability an it really is as simple as cash coming out of your pocket, or into your pocket.