Net Worth Challenge

There are a lot of people that dislike the thought of having liabilities and owing money to someone (or some company) — my wife is one of them. Her thoughts about liabilities are probably very common with many other people in society. Her philosophy on loans is to pay them back as quick as possible and pay as little interest as possible. In short, she is scared of liabilities.

I do not follow this train of thought, even though it was taught to me by family and friends. Instead, I try and maximize the gain to my net worth by utilizing liabilities in the most efficient ways possible. If you refer back to our current financial situation in October, you’ll probably notice that my wife and I have a sizeable chunk of money in our taxable brokerage accounts. This money could be used to pay down many of our liabilities (ie, house mortgage) very quickly, but this action would actually hurt us more than help us in the long-run. Since this post is merely explaining the liabilities I do have, I’ll have to save the discussion about my “liability strategies” for another day (but I did want to briefly introduce the fact that I have a strategy).

Below are the liability accounts that we had for the month ending September 2006 and an explanation of what each line-item represents.

Credit Card Balances - At the end of every month we pay our credit card balances in full. In the past I did “float” some money by carrying a balance on 0% interest credit cards and kept the money in an interest-earning money market account. However, since my wife and I are looking into purchasing a new home in the near future, I thought it best to maximize our FICO credit score and get rid of those balances. So now the only reason this item exists is because until a bill is received for our monthly purchases, a payment will not be made (we want to maximize our reward points). Due to the timing of receiving bills and the end of a month, small balances may get listed in this item. We will pay the balance in full when a bill is received, though.

House #1 Mortgage - We have a 30-year fixed rate mortgage on our duplex with a rate of 5.5%. At the time of purchase, my wife and I put down a 20% down payment on the home. Each month we only pay the principal and interest that is required by the bank and nothing more. Instead of paying more on the loan, I put a little extra money each month in our money market account. This money gets marked as “home mortgage prepayment fund” in that money market account and will eventually be used to make payments on the home mortgage —- but that time is far, far into the future.

Student Loan - I suppose a better title for this item would be student loans, since both my wife still owe money for our college education. Our education was worth every penny and has certainly given us a career boost and pay boost now that we’re in the “real world.” My wife’s student loan balance has a fixed rate of 2.875% and my student loan has a fixed rate of 1.875%. Since these liabilities have such a low rate, it makes economic sense for us to only make the minimum principal and interest payments each month. As with our home mortgage, I also set aside an extra bit of money each month into our money-market account. This money gets marked as “student loan prepayment fund” and will eventually be used to make payments on our student loans — again, this will be far, far in the future.

General Loan - This is an item for which I claim responsibility, because it predates my wife completely. I have a “general loan” from my grandparents that was used for various items several years ago. Right now my rate on this loan is 0% and there is no specified final payment date. Since I do not have to pay interest on this loan — there really is no benefit to me paying off this loan entirely. This is where my conscience sets in, because it is money that I owe my grandparents. I feel guilty not making payments, especially since this is family and they did offer me a great loan when I needed it (the word “need” could be debated). Therefore, I am making payments on this loan each and every month. I’m not sending large payments, but it is just enough to establish that I am making “good” on my debt obligation.

Other Liabilities - Along with my mortgage payment (princial and interest) each month, I also set aside money for home insurance and property taxes. I do not have the bank keeping this money in escrow for me, so it is my own responsibility to make these payments when the appropriate payment date comes up. So the money I set aside gets put into our money market account and gets marked for the appropriate category. While the money is held in our money market account (which is an asset), I still recognize that these bills will be due at some point in year. Therefore, these items need to be correctly tracked as liabilities — and this item on the liability list is used for that purpose. There are some additional categories that fit in this item besides home insurance and property taxes. In total, this item contains several categories: duplex tenant security deposits, home insurance fund, car insurance fund, and property taxes fund.

Well that’s it for our liabilties. While I look forward to seeing these amounts decrease each and every month, I’m not that worried to be carrying liabilities in the first place. All of these liabilities were thought out before we incurred them (well, perhaps not the General Loan) and we have a plan for meeting these debt obligations in the future.