Why Is Asset Liquidity Important?
Liquidity is important in cases of financial emergency. Imagine that you own a parcel of land that is quite valuable, along with some rare Picasso paintings that your dear, old Aunt Beverly left you in her will. Aside from that, you have a decent job, however your monthly expenses are around the same as what you’re making, so you can’t really save that much. But when you look at your balance sheet, you’re pretty well off, or at least “on paper.”
Now say an unfortunate financial emergency befalls you, like an unexpected auto repair or medical bill. You still have to pay your mortgage, but you can’t because you don’t have anything extra saved up, and you don’t want to borrow the money from someone else.
Now you could sell that parcel of land or one of your pieces of art, but that takes time. Appraisals must be made, buyers must be courted. These things take time – time you don’t have – and your mortgage is due before you would be able to liquidate these assets.
Those assets don’t
help you in a financial emergency because, relatively speaking, they’re not liquid enough to do you any good when you need them. When you’re thirsty, you need a drink of water. You don’t necessarily need a machine that slowly distills water droplets from the air and fills a glass of water several days later. It’s cool, but it doesn’t help you when you’re thirsty.
Examples of Liquid Assets:
- Deposit account funds (checking and savings)
- Certificates of Deposit (CDs)
- Mutual funds
Examples of Non-Liquid Assets:
- Real estate property
- Commodities (gold, oil, pig bellies)
Most lenders will suggest that it’s always a good idea to have 6 months’ worth of liquid assets available to pay your PITI in case of an unforeseen issue. That way, the lender knows you’ll be able to absorb a financial hardship if the unexpected happens.
If you’re in the market for a mortgage and have questions, check out the Mortgage Basics section of the Zing Blog!