Though we may know them by different names, they’re all still a part of our lives. Sometimes we hate them, sometimes we begrudgingly accept them. They live with us and we live with them. Ladies and gentlemen, Liabilities.
In 2021, the average American held approximately $96K in debt, a 3.9% increase from 2020, according to a report from Experian. Apart from mortgage debt, the top 3 liabilities contributing to this almost six figure number are student loans, auto loans, and personal loans. Let's take a look at what liabilities are and how they can affect you.
What is a Liability?
A liability can look like many things: a car loan, a phone bill, an “I owe you” you gave to your local grocery merchant. Technically, liabilities are a type of debt that an individual, business, or other organization has incurred. They are a legal duty or obligation that one owes to another party. Generally speaking, when someone takes on a liability and fails to fulfill them, they become liable for any damages caused by their failure to meet their obligations.
In the U.S., the average adult has around $27,000 in non-mortgage debt. The most common forms of liabilities in America include credit cards, student loans, personal loans, and auto loans. Liabilities can refer to monetary debts, and can also encompass non-monetary duties like contractual agreements and promises made in the course of business transactions.
Types of Liabilities
There are two types of liabilities:
- Current (Near-Term) Liabilities
Current liabilities are obligations that must be paid within a year or less; think accounts payable, short-term loans, and accrued expenses. These types of debts are normally used to finance day-to-day operations and require regular payments.
Let’s look at some examples:
- Accounts Payable: This type of liability is money owed by individuals or businesses to vendors for goods or services purchased on credit. For example, you order office supplies from a local vendor, but you don't pay them immediately. Everything you order, the vendor is giving you on credit under the agreement you will pay for the goods at the end of the month. Once the end of the month comes around, your accounts payable liability kicks in and you must pay for the goods received. These types of liabilities typically require payment within 30 days and will usually carry a small amount of interest until they are paid off in full.
- Interest Payments: Interest payments are fees associated with money borrowed by individuals or businesses for various purposes like education or mortgages. Simply put, interest is a charge for borrowing money. Interest payments allow lenders to have some level of return on investment for the money they let a person or company borrow. The amount due each month is determined based on the total loan amount, the rate or percentage lenders want to charge, and the length of the agreed upon repayment period.
- Wages & Taxes: Wages are regularly scheduled payments by employers to employees. Taxes are an obligatory charge set by governing bodies like the U.S. Government or your local city Mayor. Both wages and taxes are considered current liabilities as they must be paid out regularly, usually on a bi-weekly or monthly basis.
- Medical Debt: Medical debt is any debt collected as a result of medical treatment or service. Examples of medical debt include hospital bills, doctor’s office fees, diagnostic tests and lab costs, prescription medications, rehab services, ambulance services, and long-term care. Most medical debt incurred is asked to be paid within 30 days of receiving notice.
- Non-Current (Long-Term) Liabilities
Non-Current (Long-Term) Liabilities are obligations that are not due within a year, and which represent a long-term financial commitment for debtors. These liabilities typically require monthly payments over an extended period of time and often include interest charges.
Examples of Non-Current (Long-Term) Liabilities include mortgages, auto loans, student loans, and other installment loans. These types of debts usually require substantial amounts of money paid back over several years, depending on the agreement with the lender.
Other examples could include personal lines of credit that are used for large purchases such as furniture, electronics, or vacations, where repayment terms may be flexible but still represent a long-term commitment.
5 ways liabilities can affect you if you don’t pay on time
When it comes to managing liabilities effectively, it’s important for debtors to understand how they affect their lives and what options are available for handling them. Here are some key points on how liabilities can impact your financial situation:
- Increased Expenses: Current liabilities can affect individuals by increasing their expenses. For example, if Susan is making a minimum payment of $25 on a $100 loan, lenders will charge interest on the initial credit of $100 because she didn’t pay off her loan balance in full. Interest rates vary, but the charges will result in a higher overall expense. Additionally, creditors may have late payment fees or other penalties if payments are not made on time. This can further increase a debtor’s overall financial burden.
- Reduced Credit Score: Another way that liabilities can affect individuals is by reducing their credit score due to missed or late payments. A lower credit score can make it difficult for an individual to obtain financing for large purchases such as cars or homes. Lenders take into consideration an applicant’s prior history with repayment obligations when making lending decisions.
- Limited Cash Flow: Having too many current and non-current liability commitments also limits available cash flow month over month. Funds that could have been used for savings or vacation would have to be allocated towards meeting fixed monthly payment requirements.
- Loss Of Property & Assets: Failing to make payments on secured loans like mortgages can lead to borrowers losing their properties. Once a borrower is in default, foreclosure proceedings take place where legal documents outlining ownership rights become nullified. Similarly, failure with unsecured loan repayments could result in lenders seeking court orders permitting them to seize personal possessions belonging to defaulters until full sums owed are recovered through liquidation sales proceeds.
- Stress & Anxiety: Last but not least, liabilities can also cause significant stress and anxiety for individuals as they worry about how to make ends meet without having enough income coming in to cover all of their financial obligations. This could lead to sleeping problems, lack of focus, depression, or even physical ailments such as high blood pressure if debtors are unable to keep up with payments due each month.
Here is an article about how student loans affect your mental health and how you can overcome the challenge.
5 ways paying off liabilities on time can positively affect you
Don’t worry, not all hope is lost. While being late on your payments can negatively affect you, being consistent with them carries some great benefits. Here are 5 benefits of paying your liabilities on time:
- Builds Credit Score: Making timely payment on your liabilities is an important factor in building your credit score. Credit scores are based on a formula that measures your ability to pay debt off constantly and on time. A good credit score will give you access to better terms and interest rates when borrowing money for larger purchases. At times, however, paying off debt can temporarily lower your credit score. But don’t worry, it’s only temporary and in most cases, credit score increases when debt is paid off.
- Prevents Late Fees & Interest Charges: Paying off liabilities on time helps avoid late fees and extra interest charges, which can quickly add up if payments are not made each month and on time. Interest charges range in percentages and according to the type of liability you are paying off. Let’s look at a student loan, for example. If you have a 10,000 student loan at a 5.5% interest rate and a 5 year pay term, interest rate fees would be around $1,461.
- Helps you Keep Track of Your Finances: Paying off liabilities on time is an easy way to keep track of your finances, as it helps you understand what expenses are coming up and when they need to be paid. This will help you budget better and make sure that you have enough money in the right places, at the right times.
- Lowers Stress Levels: In addition to the financial benefits that come with making timely payments, there’s also the psychological benefit associated with managing your liabilities responsibly. Not having to constantly worry about missed or late payments can make a huge difference in one's overall quality of life since it removes a large source of potential anxiety and stress from your daily life.
- Improves Your Relationship with Creditors/Lenders: Making regular timely payments encourages lenders and creditors to trust borrowers who aren't afraid of taking responsibility for their own finances. This will improve communication since both parties can rely on one another without fear of falling behind due dates.
Overall, understanding how current & non-current liabilities work and the risks involved is essential for anyone dealing with large amounts of personal debt so they don't fall behind financially. Having good payment habits will help improve your overall quality of life, avoiding financial stressors like late fees, interest charges, or debt collectors constantly bothering you. At the end of the day, liabilities shouldn't be scary. There are plenty of tools on the market, but none like Lever, which you should check out. We’ll handle all your liabilities for you.