Leverage is a term that is often used synonymously with debt, and for this reason, it is important that people come to understand what debt leveraging actually means, and how it works in an ordinary financial transaction, such as buying a home for example. Let us suppose that you are looking to make a purchase of a home as an investment, and this hypothetical home costs $100,000. Let us say that you expect to earn approximately $600 every month by renting the home out to another family. If you were actually fortunate enough to have the full $100,000 amount in your savings and you bought the home outright for cash, and you sold that house a year later for $110,000, then you will have realized a before tax gain of $17,200 on your investment, which includes 12 months of $600 rent per month and the $10,000 appreciation accrued on the property’s value. Should you divide the proceeds earned by the investment made, then you will have earned a yield of 17.2 % on your capital of $100,000.
Most people, however, do not have $100,000 in the bank. Even if they did have this kind of money simply lying around, they understand that it would not be wise to tie it all up in a single investment. So let us suppose instead that you purchase the home by making a down payment of $20,000, and borrowed the balance on the purchase price, for the sum of $80,000, using a mortgage secured on the property. If the mortgage rate was 12%, then you would be making payments of approximately $800 every month, and you would be able to cover them from the rental income since they would be tax deductible.
When you sold the home at the end of the year for the $110,000, you would end up with a total net gain of $10,000, assuming that the rent was only enough to cover the loan payments, so this would be a gain of 50% on your investment of $20,000 for the down payment initially. If you had $100,000 to play with in the market at the time, you could do this same thing for five homes in the market and would have ended up with a total gain of $50,000, compared to a non-leveraged gain of only $17,200.
This is the concept of debt leverage, and it works not only with real estate but also with trading stocks using margin, taking over companies in leveraged buy outs and other financial strategies as well. Unfortunately for many people, leverage can be a double edged sword because what it does is magnifies the effect of the change in price in comparison to the original investment that you made. If the market should happen to move in your favor, but if the market moves against you then your losses will be magnified and can total a lot more than your original investment.
Photo Credits: 1
Originally posted 2009-01-13 05:09:10. Republished by Old Post Promoter
Related Posts -
The Difference Between Good Debt and Bad Debt When you see the word debt, undoubtedly the first thing that pops into your mind is a credit car bill or a car payment. For many, debt means a mortgage or other high dollar expenditures. However, there are two main forms of debt and they are very different from one...... -
How to Create Wealth With Debt On the surface, this seems like an oxymoron. How could you possibly use debt to create more money? It actually isn’t an oxymoron, but you’re going to need to change your perception of debt and classify into two different categories for this to make sense. There are many ways that...... - President-Elect Obama Roundup Another edition of the RCDL roundup. Congrats to President-Elect Obama for winning the election! Frugal | Money Saving Tips: The Christian Science Monitor takes a look at when gift-card promises go unfulfilled. Good points for holiday shoppers. Financial Ramblings writes this winter tip: The Most Beautiful Way To Save Money......
-
The Benefits of Leveraging Debt to Create Multiple Income Streams Let’s face it, debt has managed to earn itself a pretty bad name in most circles, but in many cases, this stigma is undeserved. Debt, when used properly, can help you secure your financial future. While no one is arguing that improperly used debt is a bad thing, good debt...... -
Investing in a Crisis With so much uncertainty currently present in the marketplace, one of the most vital things that you can do to invest safely in a crisis market is simply to learn from mistakes in the past. Certain sectors of the market may seem incredibly attractive in times of a crisis, it......
Related Websites -
New Loan Funded — home renovations — $25,000 at 19.5% — B Credit — DTI 46% A new loan funded (home renovations — $25,000 at 19.5%). I participated via a a manual bid the loan was NonAutofunding. The borrower had B credit and 46% DTI. As a reminder my standing orders (and manual bids) only find loans with 0 current delinquencies, 10 or less delinquencies in the last...... - Make the Most of Your FDIC Insurance Limits On October 3, 2008, Congress passed a bill that temporarily increases the FDIC insurance limits. An updated post can be seen here. With the recent collapse of IndyMac, a bank based in California, I think now is a good time to explain how FDIC insurance works and how much you......
- Your Home as an Investment? Let's Re-think this. Mr. ToughMoneyLove engages in many debates over "good" and "bad" debt and the logic of having substantial equity in your home or even paying off your mortgage. Regarding the latter, some folks insist that their home is an investment and resist building equity through their own efforts (such as making a......
-
Salton Sea, North Shore, CA Salton Sea is located in: North Shore, CA Phone: 760-393-3052 Is boating allowed? Yes, the management of the lake offers unlimited boating around the sea. There are no tides so this is a great place for beginners to learn the basics about safe boating. Is there a boat launch? There...... -
July 2008 Site and Net Worth Review (+1.61%) Net Worth Review The S&P500 basically traded sideway in July going from 1280.00 to 1267.38, or a -1% decline in value. According to NetworthIQ, my net worth dropped another -2.04% -- mostly due to the value of my house. Fortunately, my net investable assets actually went up +1.61%, or from......
Categories:
Debt, Leverage, Money, Personal Finance, Real Estate
Tags:
0 comments ↓
There are no comments yet...Kick things off by filling out the form below.
Leave a Comment