How to Start Investing: List Your Liabilities - dummies

How to Start Investing: List Your Liabilities

By Paul Mladjenovic

In financial and investing circles, liabilities are simply the bills that you’re obligated to pay, whether it’s a credit card bill or a mortgage payment. If you don’t keep track of your liabilities, you may end up thinking that you have more money than you really do.

Here are some common liabilities. You should list the liabilities according to how soon you need to pay them. Credit card balances tend to be short-term obligations, whereas mortgages are long-term.

Liabilities Amount Paying Rate %
Credit cards $4,000 15%
Personal loans $13,000 10%
Mortgage $100,000 8%
Total liabilities $117,000

Here’s a summary of the information:

  • The first column names the type of debt. Don’t forget to include student loans and auto loans if you have them.

    Never avoid listing a liability because you’re embarrassed to see how much you really owe. Be honest with yourself — doing so helps you improve your financial health.

  • The second column shows the current value (or current balance) of your liabilities. List the most current balance to see where you stand with your creditors.

  • The third column reflects how much interest you’re paying for carrying that debt. This information is an important reminder about how debt can be a wealth zapper. Credit card debt can have an interest rate of 18 percent or more, and to add insult to injury, it isn’t even tax-deductible.

If you compare your liabilities and your personal assets, you may find opportunities to reduce the amount you pay for interest. If you pay 15 percent on a credit card balance of $4,000 but also have a personal asset of $5,000 in a bank savings account that’s earning 2 percent in interest, you may want to consider taking $4,000 out of the savings account to pay off the credit card.

If you can’t pay off high-interest debt, at least look for ways to minimize the cost of carrying the debt. The most obvious ways include the following:

  • Replace high-interest cards with low-interest cards. Many companies offer incentives to consumers, including signing up for cards with favorable rates (recently under 10 percent) that can be used to pay off high-interest cards (typically 12 to 18 percent or higher).

  • Replace unsecured debt with secured debt. Credit cards and personal loans are unsecured (you haven’t put up any collateral or other asset to secure the debt); therefore, they have higher interest rates because this type of debt is considered riskier for the creditor.

    Sources of secured debt (such as home equity line accounts and brokerage accounts) provide you with a means to replace your high-interest debt with lower-interest debt. You get lower interest rates with secured debt because it’s less risky for the creditor — the debt is backed up by collateral (your home or your stocks).

  • Replace variable-interest debt with fixed-interest debt. Think about how homeowners got blindsided when their monthly payments on adjustable-rate mortgages went up drastically in the wake of the housing bubble that popped during 2005–2008. If you can’t lower your debt, at least make it fixed and predictable.

The year 2011 was the 15th consecutive year that personal bankruptcies surpassed the million mark in the United States. Corporate bankruptcies were also at record levels. In 2012, total college debt surpassed $1 trillion. Make a diligent effort to control and reduce your debt; otherwise, the debt can become too burdensome.