Business and Finance

Managing the debt on your personal balance sheet
Written by Alexis Swann

Left unchecked, a personal balance sheet can start to look a lot like an untended garden. If you ignore it, it will grow out of control and accumulate unwanted vegetation. In a garden like that, it’s often hard to tell the flowers from the weeds.

And just as you would tend a garden regularly, you also should review and clean up your balance sheet on a routine basis, says Paul C. Hornung, senior credit officer of Wells Fargo Private Bank. He suggests that your liabilities are a good place to start, and explains, “The goal is to grow your net worth over time. You should look at your balance sheet and think about the amount of leverage in it. If your debt keeps getting bigger over time, your net worth is going to get smaller.”

There are three dimensions to evaluating the amount of leverage in your balance sheet:

• Debt payments. Assess whether you can afford your payments and whether you are comfortable with the amount you’re paying, based on your income
• Debt-to-asset ratio. Consider the amount of debt on your balance sheet compared to the amount of assets
• Type of debt. Understand the type of debt on your balance sheet

Define Your Debt
In addition to calculating your debt, analyzing it requires categorizing it, Hornung says. He notes there are three basic types of debt on the typical individual balance sheet:

• Mortgage debt. This is the first and most obvious category of debt and consists of the loan you used to buy your house.

• Investment debt. This kind of debt is used to pay for assets, such as rental properties. Your investment should generate a sufficient rate of return to carry the debt.

• Lifestyle debt. There are two kinds of lifestyle debt. The first kind includes credit card debt, which typically is used for its convenience factor to buy groceries, gas, entertainment and other everyday purchases. The second kind of lifestyle debt, such as a home equity loan, is used to finance major purchases, such as college tuition or a home remodel, to close cash flow timing gaps.
Be Proactive! Do a Report Card on Your Balance Sheet

Assess Your Risk Exposure
Whether your debt is helping or hurting your personal balance sheet depends on several factors, including whether there is any expected return on your investment. Because they can generate income or lead to capital appreciation, for instance, mortgage debt and investment debt are typically more welcome on a balance sheet than lifestyle debt, which tends to cost money rather than make it. If your lifestyle debt is growing over time, it may suggest that you are living beyond your means.

Still, by definition, all debt carries risk and, therefore, should be managed carefully. “Debt is an extra expense that you choose to incur,” Hornung says. “The most obvious risk is that your disposable income is reduced due to loan payments. Ensure that your expected cash flow is adequate before taking on the debt burden. Would an interruption to your cash flow cause the debt to become a problem? If something happens—you get sick and can’t work, you get laid off from your job, there’s a divorce and the family income declines by half—meeting those debt payments can become a real problem.”

Protect Your Financial Future
No matter the type or amount of debt, the best way to mitigate its risks is to assess it in relation to your income, Hornung says. “There is no magic number for the right amount of leverage,” he says. “The most important thing is to make sure that the debt you’re taking on is at a relatively tolerable level in relation to your overall financial picture.”

Even if you can afford to make all your monthly loan payments, if you’re not investing in assets that are growing, your balance sheet is decidedly unbalanced, Hornung concludes. “Debt isn’t intrinsically bad,” he says. “But if the asset against which you took out the loan is not earning a rate of return that matches or exceeds the interest that you’re paying on your loan, it’s probably not a very good investment. In that case, I would say it probably makes more sense to sell the asset, pay off the loan and stop earning a negative return on that investment.

Alexis Swann is a Private Banker and Senior Vice President for the Greater Virginia region of Wells Fargo Private Bank.

As part of The Private Bank, Mrs. Swann works with clients to understand their needs and then coordinates a team of specialists to provide wealth management services, including banking, credit, investment management and trust and estate services through Wachovia Bank, N.A., as well as brokerage services through Wells Fargo Advisors, LLC.

For more information Contact Alexis Swann at 757-667-3522

Wells Fargo Private Bank provides products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries.
Wells Fargo does not provide tax or legal advice. This article is for information and education purposes only, and should not be construed as tax or legal advice, which Wells Fargo and its affiliates cannot provide. Please consult your professional tax and legal advisors to determine how this information may apply to your own situation.
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