Liabilities are negative assets that you owe money on. They can be an expense you have coming up in the future, such as mortgage or car loan payments, or they can be current expenses like credit card bills and other loans. Regarding your balance sheet, liabilities are one of the three primary assets you need to account for.
The different types of liabilities include:
Short-Term Liabilities
These are the smallest liabilities, but they can still significantly impact your financial standing. Credit card bills and personal loans are two types of short-term liabilities that you need to pay off within a few months, or you could negatively affect your credit score. You can view your credit score on Credit Karma, a free website that you can use to monitor your credit score. High short-term liabilities could cause a low credit score, making it much more challenging to get approved for large purchases like a home or car.
That is why keeping your short-term liabilities low is essential to pay off credit cards and take out as little as possible in personal loans. Short-term liabilities also have much more flexibility in terms of repayment. Credit cards typically have a minimum monthly payment, and personal loans usually have a higher minimum amount due at the start of the loan. However, short-term liabilities are generally paid off in the order they were incurred.
Credit Card Liability
Credit cards are a type of short-term liability that many people use as a standard form of payment. Credit cards provide a convenient way to pay for everything from groceries to gas. However, they are also one of the most dangerous types of liabilities. If you do not pay off the total amount on your credit card each month, you will pay massive amounts of interest. If you cannot keep up with the payments, you might end up in debt for years, paying back even more than what you initially charged. You must try to avoid using credit cards, and if you have to use one, you must pay it off as quickly as possible.
Long-Term Liabilities
Long-term liabilities are much more significant and account for most of your liabilities. These include your mortgage, car loans, and student loans. Long-term liabilities are generally considered to be anything with a term lasting more than one year. These liabilities can be beneficial in the long run, but they can put a lot of pressure on your bank account early on. If you can pay off your long-term liabilities quickly, you will become much less financially encumbered.
You can face steep fines and penalties if you fail to pay these off on time. That is why it is so crucial that you stay on top of these payments, no matter how large they are. Long-term liabilities are more rigid when it comes to repayment, but one benefit they have going for them is that they are tax deductible. That means you could receive back some of the money you put into paying off these liabilities.
Mortgage Liability
You are creating a liability when you take out a mortgage to purchase a house. A mortgage liability is a long-term liability you will most likely have to pay off for the rest of your life. A mortgage is usually a few hundred thousand dollars, and the average length of a mortgage is about 30 years. It is important to note that you do not pay off the total amount of your mortgage at once. Instead, you make monthly payments towards your mortgage principal, the amount of money you borrowed initially. You can lose your home if you fail to make timely mortgage payments.
Auto Loan Liability
You borrow money from the lender when you take out an auto loan or lease a car. With that loan, you agree to pay a certain amount over a certain period. If you fail to make timely payments, you could lose your car, or the lender could try to garnish your wages.
Asset backed Liabilities
Asset-backed liabilities are financial instruments issued by institutions like banks or insurance companies. They represent a claim on tangible assets, such as real estate or corporate bonds. When asset-backed security is sold, the money raised is used to buy the actual asset. The bank then uses its profits to pay off the loan and make payments to investors who purchased the security in return for a premium. Asset-backed security can be either equity or debt. Equity-backed securities are securities backed by real estate, corporate bonds, and other assets, while loans back debt-backed securities.
A significant advantage of asset-backed securities is that they can provide necessary liquidity support to firms that need cash. Asset-backed securities also have attractive tax benefits compared with traditional debt. Asset-backed securities generally do not trigger any additional taxable event when redeemed or on maturity (even if redeemed at par). Asset-backed securities have less market risk than traditional debt because they are typically issued at fixed interest rates and do not involve any credit risk management activities.