Building wealth is about so much more than eliminating debt. Most of the time, successful real estate investing requires using debt as leverage to purchase properties. Leverage in real estate allows you to borrow money and invest in property in order to amplify the return on your investment.
If you own a home, odds are you used a loan to purchase your property. That’s leverage! So, the law of leverage explains why you can use $20,000 to purchase a $200,000 asset. This blog outlines the function of leverage to help you decide if real estate investing (and how much) is right for you.
The Function of Leverage In Real Estate
The primary benefit of leverage is that it allows you to purchase property for a fraction of its value. Let’s look at an example of someone who wants to purchase a rental property but may not have a lot of cash to do so. Unless you purchase a property in cash, you will use a mortgage lender to loan you the amount the house is worth (after your down payment.) This means you don’t need $200,000 to purchase a $200,000 home. All you have to do come up with is a 10% downpayment (less if you’re a first-time home buyer, and at least 20% if you want to avoid private mortgage insurance.)
There are a number of ways to leverage other people’s money when you’re ready to invest in real estate. Traditional mortgages are one way to use leverage to purchase a primary residence at lower interest rates. Portfolio loans are a faster and more flexible option that focus on the quality of your investment. Some real estate investors may not realize that they can also qualify for business credit lines, which could be another way to use debt to increase your investment opportunities.
While you can build wealth with other investment strategies such as stocks (and we do recommend a diversified portfolio with hard and paper assets), stock brokerages won’t allow you to use nearly as much leverage.
Advantages Of Using Leverage In Real Estate
To ut the benefits simply, leverage increases the return on your investment. The current national average real estate appreciation rate is 2 percent month over month and an estimated 14.5 percent year over year, according to Rocket Mortgage. Let’s say you put down $10,000 down on a $100,000 property. The return on your investment will come from the overall property value, not your down payment!
When you use other people’s money to buy property instead of paying for it in cash, you may also have more chances to expand your portfolio. If you don’t start out as a wealthy investor, using leverage in real estate can make it possible for you to put money down on multiple properties.
The power of leverage makes it possible for you to use a little bit of money to control a larger asset. While the return on your investment can be magnified through leverage in real estate, there are also some risks involved. This is especially true for inexperienced investors.
Risks Of Using Leverage In Real Estate
Leverage in real estate comes with its fair share of benefits, but some immediate risks can’t be ignored. In the same way that you can increase the return on your investment through the power of leverage, these factors can also work against you. If your property yields a negative return, your losses could be magnified.
You can also run into other issues if you purchase a rental property. You could lose out on money every month if you took out a mortgage for a rental property that is struggling with vacancies. In the event that you default on your mortgage loan and your lender takes the property, you’ll lose more than just your investment. There’s a chance that your personal assets could also be compromised.
So, Should You Invest in Real Estate?
Residential real estate has steadily increased by about six percent a year in the United States. This historical increase makes real estate investing via leverage a worthy investment strategy to consider. Before you jump in on your next investment, it is important to seek professional counsel and do your research. We created The WealthBuilders Real Estate Workshop to teach you how to mitigate risks and maximize profit. Click here to learn more.