Many people believe their home is their biggest asset. Often people gloat about how much their own home is worth over what they owe the bank, but without selling or in some way realising these profits, what does it really mean? It is for most the single biggest financial purchase they will make. So why then do I look at an owner-occupied property as a liability?
Let me introduce to you a little thing called the asset/liability quadrant. It’s a fairly simple diagram that can be used for almost any purchase to determine if it is an asset or liability. The two other important factors to consider are whether the purchase will appreciate or depreciate. We need to understand the two:
- Appreciate – Goes UP in value over time.
- Depreciate – Goes DOWN in value over time.
We then need to distinguish the key differences between an asset and a liability.
- Asset – Pays you and income.
- Liability – Costs $$$ to hold.
We can apply the quadrant to purchases such as a new car for example which drops in value almost immediately after driving off the showroom floor (Depreciates) and costs money to run, maintain, insure, etc (Liability). Therefore labelled a ‘Depreciating Liability’.
Going back to our earlier example, for simplicity reasons let us assume that your owner-occupied property goes up in value over time (we can only hope!) Using the same quadrant, we can start to see that although the property is appreciating there is no form of income and costs money to hold. The mortgage repayments, council rates, sewer charges, maintenance and insurances are all paid for using after tax dollars that cannot be deducted. An owner-occupied property is in fact an Appreciating Liability.
Compare this to an investment property that has rental income that exceeds the (tax deductible) expenses and is going up in value, then it can be seen as an Appreciating Asset.
A simple guide to achieving financial success is to rid yourself of depreciating liabilities and target appreciating assets. This quadrant is a handy tool to assist this.
– The Tattooed Investor