Credit Sesame looks at how credit cards impact net worth.
Net worth is an important measure of the progress you’ve made financially. It measures how much money you’d have left over if you sold everything you own and used the proceeds to pay off all your debt.
How do credit cards impact net worth? It depends on how you use them.
Since debt subtracts from net worth, having credit cards can reduce your net worth. On the other hand, wealthy people often have more credit cards than poorer people, so having credit cards certainly is not a kiss of death when it comes to building net worth.
Again, it all comes down to how you use your credit cards. Understanding the relationship between credit cards and net worth can help you use those cards more effectively.
What Exactly Is Net Worth?
From an accounting standpoint, net worth equals assets minus liabilities.
So what does that mean?
An asset is anything you own that has monetary value. This could be financial assets like bank and investment accounts, physical property like a house or car and even any personal possessions that would have some resale value.
An accounting liability is anything you owe. So, any debt – mortgages, car loans, student loans, credit card balances, etc. Your accounting liabilities are subtracted from your assets to arrive at net worth.
The importance of net worth as a measure of financial health is that it represents what you own free and clear. It’s possible to have a big house, a luxury car, lots of expensive jewelry – and still struggle with debt. This can happen if the purchases were made on borrowed funds.
That’s why what you own doesn’t necessarily indicate how healthy your finances are. It’s only when you balance what you own against what you owe – assets minus debt – that you get the full picture of financial health.
How Do You Calculate Net Worth?
One way to think about net worth is that it’s the amount of money you’d have if you converted all your finances to cash – sold all your assets, and paid off all your debts.
You’re not likely to do that, but you can still calculate your net worth by figuring out what would happen if you did.
Calculating the value of your assets
First, simply add up the value of all your assets. For things like bank and investment accounts, this is easy – just take the market value from the most recent statement.
For other possessions, you may have to estimate a value. For things like a house or a car, this is fairly straightforward. There are plenty of online resources that estimate values for real estate or used cars.
When it comes to things like jewelry, art, collectibles or electronics, you may not be able to find an exact value. However, these items usually represent a fairly small amount of a person’s net worth. If you think yours are more valuable, you should probably get them evaluated so you can insure them appropriately.
Once you have a list of your assets and an estimate of the value of each, simply add them all up. The result is the total value of your assets.
Calculating your liabilities
As for your liabilities, these are the amounts that you owe.
Note that for loans, that means the remaining balance you have, not the amount you originally borrowed. So, if you originally took out a $200,000 mortgage but have paid off $50,000, this would be a $150,000 liability.
In some cases, the amount you owe can actually be more than you originally borrowed. For example, people who defer student loan payments may be running up interest charges before they start paying down what they borrowed.
So, if you took out a $25,000 student loan and had $5,000 in interest charges before you started making payments, you’d now have a $30,000 liability.
Credit card debt is another example where interest charges can have a big impact on what you owe. In any case, the liability is your outstanding balance, whether that came from what you originally charged, from interest on those charge amounts, or from fees.
Make a list of the amount of all your debts and add them up. This is the total amount of liabilities you have.
Now subtract that total from the value of all your assets to arrive at your net worth.
How Do Credit Cards Affect Net Worth?
Credit cards are a little different than other debts when it comes to their effect on your net worth. That’s because you can have a credit card without owing a balance on it.
So, if you have a loan, you can assume that loan will subtract from your net worth. However, a credit card won’t subtract from your net worth if you don’t owe a balance on it.
In fact, wealthier people are more likely to have credit cards than poorer people. So clearly having credit cards does not directly drag down your net worth. However, there may be an indirect relationship.
Having several credit cards may lead you to build up more credit card debt. After all, with more credit limits to work with, you could run up a larger total balance.
Since credit card balances are a liability that subtracts from net worth, the more credit card debt you owe the more it will reduce your net worth.
In short, just having credit cards does not directly lower your net worth. However, if it results in you owing more debt, then that debt will have a negative effect on net worth indirectly. Credit cards impact net worth if you end up being unable to pay off the balance.
How Important Is Net Worth to Financial Health?
Net worth is a significant measure of financial health because it balances out both assets and liabilities to show your true wealth.
Thus, building net worth is a measure of financial progress over time. It shows the total amount of financial resources you have to fall back on.
However, net worth is not the only measure of financial health. Here are some other important indicators:
- Income. Net worth measures what you already have. Income measures what you have coming in. So, income can be an indicator of future net worth. For younger people who haven’t had much time to accumulate assets, income is often a more important measure of financial health than net worth.
- Liquid assets. These are assets that are readily available for spending. This could include anything from a checking account balance to investments you can sell at any time on a public exchange. It does not include property like your home or car, which would take more time to sell and whose value might suffer if you had to sell them quickly. Having liquid assets to cover your routine expenses is an important measure of financial health. Otherwise, you wouldn’t be able to pay the bills without incurring the expense of borrowing.
- Credit score. Credit score is an interesting measure of financial health because it is not based on how much money you make or how big your net worth is. Credit score is based solely on how you use credit, including your history of making payments on time, how much you currently owe and how much credit you have available. Credit score is important because it affects your ability to borrow so you don’t have to rely solely on income and liquid assets.
What credit score and net worth have in common is that having credit cards doesn’t change either directly, but it can affect them indirectly. Running up too much debt, especially if you fail to make payments on that debt, will detract from both net worth and credit score. So, although credit cards impact net worth indirectly, sometimes, it is just the wrong time to use credit cards.
That’s a reminder of how important responsible credit card use is to growing your net worth and your financial health in general.
Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.