Those of you who are new to property investment can sometimes be overwhelmed with the amount of property jargon used, fortunately most of it is easily explained. One of the more common things we are asked is:
What is Leverage?
The definition of leverage is, to gain an advantage through the use of a tool. In property, the tool we use is called a mortgage.
We use a mortgage to leverage by using the borrowed money from the bank to make an investment, and the subsequent return on the investment.
Mortgage leverage is a way to acquire property that is worth more than the asset or equity of the investor to increase wealth. Leverage can allow you to increase the return on investment on your property portfolio and significantly increase your wealth.
Why Leverage is your secret weapon to property investment success.
Below are two examples to illustrate the use of financial leverage, or simply leverage.
Susan uses £200,000 of her cash to purchase a rental property with the total cost of £200,000. Susan is not using financial leverage as she has not used a mortgage.
Wendy uses £200,000 of her cash and borrows £400,000 via mortgages to purchase 3 rental properties having a total cost of £600,000. Wendy is using financial leverage and is controlling £600,000 of property but only using £200,000 of her own money.
If the properties owned by Susan and Wendy increase in value by 20% and are then sold, Susan will have a £40,000 gain on her £200,000 investment, a 20% return.
Wendy will sell her properties for £720,000 and will result in a gain of £120,000. Wendy has made a £120,000 gain on her £200,000 investment, resulting in Wendy making a 60% return.
So because Wendy used mortgages to leverage she made a 300% more than Susan investing in the same asset!
When property increases in value leverage is a stunning investment tool. It can be the difference between financial riches in the long term or mediocre returns. It is important to remember that leverage works against you in the same way if property prices fall. So it is important to invest for the long term and protect your cash flow.
Cash flow is the king. If all your mortgage costs and expenses are covered you still have extra cash flow coming in from a property, then investing in property over the long term with leverage can produce fantastic results.