Think about the word asset. What exactly does it mean? An asset is an item of property, a person, thing, or quality regarded as useful or valuable. That definition is broad enough to allow most people to justify most of what they buy as an asset. You convince yourself to buy a big, expensive car because it will “hold” its value in case you want to sell it later. But selling this asset usually means acquiring debt to obtain another car. Doesn’t that defeat the purpose? Does a banker consider your Lexus an asset? Does it improve your chances of getting a home loan? Not if you still owe money on it.
We amass a great deal of things, but how much of that stuff maintains its value? Did you know that there are more than 35,000 self-storage facilities in this country? Americans’ houses and garages are overflowing with so much stuff that we have to rent extra space to keep it in. I know someone who rented space in a self-storage facility for her clothes because she ran out of room in her closet. Crazy!
I want you to think about all the stuff you have because, ultimately, I want you to determine whether too much of your income is being devoted to servicing debt to pay for personal property that depreciates every year.
There are four types of assets that make up your net worth. Three don’t require you to rent self-storage space and are more likely to put you on the path to financial security. They are called appreciating assets.
The second asset category is personal property. This includes your automobiles, furniture, clothing, and electronic equipment. Technically, personal property is counted on the asset side of your personal balance sheet. However, once you walk out of the store or drive off the car lot with this type of asset, it immediately loses a great deal of its value. These assets are otherwise known as depreciating assets.
Want to see how much of your income is spent to acquire assets that aren’t likely to make you wealthy? It’s not a perfect formula, but figuring out your debt-to-income ratio will give you some idea of where your money is going. This is a number, expressed as a percentage, that compares the amount of your debt (excluding mortgage or rent payment) and your monthly gross income.
Mortgage lenders look at the debt-to-income ratio all the time. When you apply for a mortgage, a lender will first determine the percentage of your gross monthly income that goes toward housing expenses. Typically, your monthly housing expense should not be greater than 28% of your gross monthly. Mortgage lenders will then look at your total-debt-to-income ratio (all your debt obligations including your mortgage payment) to determine whether you are able to handle a home loan. The maximum ratio they typically like to see is 36%, although increasingly lenders have allowed borrowers to have a total-debt-to-income ratio as high as 50%. Still, your basic debt-to-income ratio compares your debt