Financial leverage in real estate means to borrow money or take a loan to buy a property with the intent to earn a greater rate of return than the cost of borrowing.
Give me a lever long enough and a place to stand and I will move the entire earth
Archimedes – 200 BC
The biggest advantage of leverage is that it helps you to become rich very quickly. It allows you to buy more property with your capital. It also allows you to diversify your portfolio that reduces risk and increases returns. Mortgage interest tax benefits help to reduce your taxes and increase your cash flow.
The fastest way to massive wealth creation is through the right kind of leverage. What most gurus don’t tell you is that the fastest way for you to lose wealth is to apply the wrong kind of financial leverage. You have to understand how leveraging works.
Whenever you apply leverage it automatically increases your risk. To create massive wealth through financial leverage you have to understand how to control risk.
You apply financial leverage when you either control or purchase a property with little or no money down. You are unleveraged when you buy a property with cash.
Leverage = Borrow Money to Buy Property
Unleveraged = Use Cash to Buy Property
Financial leverage plays an important part in dramatically changing your return on investment. What some investors fail to take into account is that leverage changes cash flow from a property. Higher your leverage and cost of borrowing lower will be your cash flow from the property.
The first important lesson is that you apply financial leverage only to the extent that your cash flow will permit. Investors get into trouble when they apply more leverage than what the cash flow from the property will allow.
You have Positive Leverage when your returns increase with debt financing. When your returns go down with debt financing it is Negative Leverage. Neutral Leverage is when your returns neither increase or decrease with debt financing.
Your aim should always be to apply positive leverage but there are occasions when you can succeed with negative leverage. One example is when flipping properties.
It is important to know that financial leverage affects your cash flow, equity build up, tax refunds and appreciation. If you are a savvy investor you have to know how leveraging impacts various fundamentals of your investment.
You may like to read more about Appreciation Leverage, Cash flow Leverage, Mathematics behind Leverage, Risks involved with Leveraging and how you can contain these risks.