When is your house a liability? Does the fact that you have a mortgage make your house a liability? Or do you have to owe more than the house is worth? What is a liability, anyway?
Well, it depends. Looking at your house from a financial perspective, which you should do because if you’re like many people in the United States, most of your wealth is “tied up” in your house, it is not a liability. A liability is defined as something you owe to someone else. You do not owe the house to the person from who you purchased it, nor do you owe the house to the bank. You may owe the balance of your mortgage.
A house, like any other object that comes into your possession, is classified as an asset. An asset is something you own. A house has a value. Whether you assign the value as the price at which you purchased the house or the price at which you believe you can sell the house, that amount is how much your house is worth.
You can offset the value of the asset with the value of the mortgage, your liability. Your house, an asset, subtracted by your remaining mortgage, your liability, results in your wealth due to your house. That’s commonly called your “equity,” but that has a murky definition, too.
So why do so many people claim that your house is a liability if it’s clearly incorrect from a financial standpoint? Most of this stems from one personal finance “guru.” Robert Kiyosaki, a successful marketer of products, believes an asset is anything that provides cash to you, while a liability takes your cash away. These are not the traditional meaning of the words, but this establishes a framework for the ideas Kiyosaki tries to sell. Kiyosaki believes you should strive to increase the assets that provide positive cash flow (Kiyosaki-assets) and reduce the assets that require negative cash flow (Kiyosaki-liabilities).
The concept is sound, but Kiyosaki’s use of the words “asset” and “liability” angers those of us who understand finance and prefer not to confuse the general public by redefining words. But taking a step back from finance, consider this:
There is at least one other legitimate definition or “sense” of liability. In a broader sense, a liability is anything that puts an individual at a disadvantage. Yes, debt is a liability, both financially and generally. You may love your children, but if they’re chronic behavior problems, they may be a liability.
If you own a business that makes millions of dollars each year — and wouldn’t that be nice — chances are you could sell that business if you need to, and command a very high price. That business is a good example of an asset (even if the business itself contains assets such as buildings and liabilities such as debt). But if that business is legally risky, and there is possibility of being arrested for operating it, you could argue that the business is a liability to your ability to continue living freely.
Once you start looking at the big picture, the line between asset and liability, usually neatly drawn down the center of the balance sheet, looks a little fuzzier.
Ask anyone with a financial background whether your house is an asset or liability, and they will unequivocally tell you that it is an asset, contributing to the total of your net worth. but that definition only takes you so far. If owning your house prevents you from using your money for better purposes, you could argue that it is a liability in the broader sense of the word.
Just don’t try to put the value of the house on the right side of your balance sheet.
Update: In response to this post, Mighty Bargain Hunter shares his thoughts about the practicality of Kiyosaki’s redefinitions.
Updated October 17, 2012 and originally published February 16, 2009. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.