Financial Literacy

Defining Asset vs Liability

Money is just another problem that needs to be solved. And to understand a problem it is critical to define it properly. Albert Einstein famously said: “If I had an hour to solve a problem I’d spend 55 minutes thinking about the problem and five minutes thinking about solutions.

And at the core of every problem definition lies the vocabulary and the true meaning of words. One of the greatest tragedy in modern age is not being able to properly define asset and liability.

So let’s keep this simple:

  • an Asset puts money in your pocket
  • a Liability takes money out of your pocket

Now if you’ve ever applied for a loan to buy a home, you may have stumbled upon a banker lauding how great of an asset your home is. Spoiler alert: it’s not. Or more precisely not for you.

Let me explain, to enjoy your home you’ll probably have to pay your mortgage, which takes money out of your pocket. You also have to pay property taxes which also takes money out of your pocket. You’ll need a home insurance, which again takes money out of your pocket. You’ll also need to cover expenses associated with maintaining your home, which yet again takes money out of you pocket. How much money does your home put in your pocket? $0. So from your perspective, your home is a liability not an asset.

Now looking at it from your banker’s perspective, the mortgage interests you pay on your loan brings money in your banker’s pocket. Therefore from your banker’s point of view, your home is an asset.

And with this comes an important corollary around assets and liabilities: the nature of a given resource usually does not define whether it is an asset or not. Instead the usage of such resource defines whether it’s an asset or not.

As seen with your home: it is a liability for you, but the exact same home is an asset for your banker.

Similarly if you own a rental property, which is just another home, and you make a profit after paying your mortgage and the associated expenses, then the rental property is an asset, because it puts money in your pocket.

Note that by integrating an investment component to your housing, you can limit or even sometimes eliminate the liability. And since the housing cost is usually the biggest household income for most people it’s well worth taking a hard look at it. See what house hacking can do for you.


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