The Hidden Side of the Balance Sheet – Part 2

The Hidden Side of the Balance Sheet – Part 2

This is a continuation of last week’s blog post – The Hidden Side of the Balance Sheet Part 1.

We see people with a lot of expensive stuff and we think it belongs to them. But we don’t know that. We don’t see the hidden side of their balance sheet.

Owing what you own

When people show us the assets that display their wealth, we don’t know if they own them outright, or if they borrowed the money to buy them and are still in debt. If they borrowed the money to buy that item, we don’t know how much money they borrowed, how much they still need to pay for it, and how long they still have to pay it off. If a person still owes lots of money on an item, they don’t own it yet.
Let’s talk about debt for a minute. In our modern world, lots of purchases are fuelled with debt. Most adults have a credit card. Almost everyone who buys a house will have a mortgage. Many of us have car loans and personal loans. Education, business and investment loans, lines of credit and peer-to-peer lending – the options are endless. When it’s used effectively, debt can be great helper to achieving financial success. When it isn’t, the results can be devastating.

The funny thing about debt is that we know that we have it and how much we have – but we forget that others have it too. We see these outward measures of success and we think that other person has the full ownership of those assets. We forget that the beautiful home may not really be theirs, that they might be groaning under the weight of a multi-million dollar mortgage. That luxury car might have been bought on finance to help impress their equally burdened friends. The awesome leather lounge suite may have been purchased on an interest free loan. They could still be paying for those amazing holiday snaps on the credit card in five years’ time.

An example

In the article with the ‘millennial multi-millionaire’, it first stated that he had several properties worth over $2 million. A closer reading however showed that he didn’t actually own in excess of $2 million in property yet. The article mentioned, in a throw away line half way through the piece, that he had used equity to buy more houses. What does that mean?

Equity means the part of the property that he owned, either due to his original deposit paid, the principal repayments he made, or a rise in the property’s value. He had started with a small deposit and large mortgage on one property. After paying that mortgage down for a little while, he used the equity in that property to borrow more money to buy more properties. In other words, he borrowed money from the bank to buy a property, and then used the small bit of the property he owned to borrow more money from the bank to buy another property. And then another property and then another. If you’re comfortable with the risk, there’s nothing wrong with using this strategy. It’s a common (though risky) way real estate investors use to buy more properties and create an investment portfolio.

The key thing to note though is that he didn’t actually own $2 million worth of property yet. Sure, the assets side of his balance sheet read: $2 million! The liabilities side, the massive debt, the hidden side of the balance sheet, also read almost $2 million. He might be worth $2 million one day. Until he pays off that debt, the banks are the millionaires in his story.

What you see isn’t always what’s ticking beneath the surface. While many people may own their luxury goods, many others are sitting on a debt bomb they keep from exploding only by paying the minimum required. Looking at them from the outside, they have all the assets of success. What you don’t see is the constant sweat they’re under blowing out the liability match.

Think for yourself!

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