Image © jenny w.
Believe it or not, many people don’t know how their credit cards affect their net worth. A lot of people don’t exactly know how their net worth is calculated and therefore they confuse their net worth with their credit worthiness. However, the truth is that your personal net worth and your credit worthiness are two completely separate (but equally important) parts of your financial well being. Just because someone has many credit cards doesn’t necessarily mean that he or she has a positive or high net worth. The truth is that the way someone manages their credit products can actually have a negative effect on their personal net worth.
How is Your Net Worth Calculated?
Your personal net worth is calculated by subtracting all of your liabilities from the total value of your assets. Liabilities include any type of debt that you owe in the form of credit cards, lines of credit, student loans, mortgages, and overdraft protection. Assets include personal savings, investments, retirement accounts, employee share ownership plans and bank account balances. Assets also include the value of your home, a collection of artwork, jewelry, your car, home furnishings and precious metals (i.e. gold and silver bars).
Credit cards do not increase your net worth because credit cards are not assets, they are liabilities. If you have a credit card that you never use or if you have a credit card and pay off the balance every single month it is still considered to be a financial liability because the total credit limit is available for use at any time. Liabilities decrease the value of your net worth, even if you acquired the debt in order to purchase an asset.
It is very common for people to apply for a personal loan or line of credit in order to purchase an asset such as a home or a car. The amount of the loan will be very close to the value of the asset in the early years and therefore your personal net worth will reflect the liability. However, as the loan gets paid down and the value of the asset increases your personal net worth will also increase. Whenever you have a depreciating asset such as a car, your net worth will probably not be impacted in a positive way unless the loan is paid off in full and if the asset still has some value.
What is Your Personal Net Worth?
Take a moment and try to calculate your net worth. Add up the value of all your assets both tangible (fixed assets) and intangible (liquid assets) in one column. Then add up the value of all your liabilities including loans, credit card balances, mortgage loan balances, overdraft protection and so on in another column. Now subtract the amount of your liabilities from the total value of your assets. What is your total personal net worth?
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