Leverage

Leverage is a financial strategy that involves using borrowed capital to increase the potential return of an investment. For example, if you invest $10,000 of your own money into real estate, but take out a loan of $90,000, your total investment becomes $100,000. If the property appreciates by 10%, your investment is now worth $110,000. After paying off the loan, your profit is $20,000, yielding a 200% return on your initial $10,000 investment, rather than just a 10% return without leverage.

However, leverage is a double-edged sword. While it can magnify gains, it also amplifies losses. If the property value decreases by 10%, your investment is now worth $90,000, resulting in a loss of $10,000. This means you've lost 100% of your own capital. Many investors mistakenly believe that leverage always leads to higher profits, ignoring the increased risk and potential for significant losses.

To utilize leverage wisely, it's essential to assess your risk tolerance and the stability of the investment. Always have a plan for downturns, such as maintaining liquidity to cover loan payments during tough times. Also, consider the cost of borrowing; if interest rates are high, the benefits of leverage may diminish. Key takeaway: use leverage strategically to enhance your investment potential, but remain vigilant about the risks involved.