Leverage

Leverage is a tool that fancy finance professionals use to juice their returns. The takeaway is that it makes your investment have a higher risk and higher reward. It always receives a lot of negative attention during down times in financial markets (such as late 90s technology and the Great Recession) due to it creating wild swings in markets. When used properly, however, leverage is a powerful tool that is commonly used by Americans.

What is leverage?

Leverage is investing with borrowed money. At first it sounds scary, but consider a mortgage. When many consumers purchase a house, they borrow 80% or more of the home price on the promise to pay it off over time.

Take the below example. With a conservative 3.0% home price growth rate, the math shows that leveraging provides a significant upside on return for a home purchase.

Leverage

5-to-1 (80% LTV)

10-to-1 (90% LTV)

20-to-1 (95% LTV)

Down Payment

$50,000

$50,000

$50,000

House Price

$250,000

$500,000

$1,000,000

Return

3.0%

3.0%

3.0%

Value at Year 0 (Down Payment)

$50,000

$50,000

$50,000

Value at Year 1

$57,500

$65,000

$80,000

Return on Investment*

15.0%

30.0%

60.0%

 *ignores cost of debt

This is how a lot of older Americans have been able to build a substantial amount of home equity. Debt is fixed so inflation diminishes the cost of debt ($200,000 in 1986 is more substantial of a debt than $200,000 in 2016) and allows the asset that backs the security to gain significantly over time.

With a long-term horizon (10 years or greater), leverage provides a powerful tool to increase one’s returns.

Learning about leverage can blow your mind

But That’s Only Mortgages!

There are opportunities for leverage in other forms of debt besides mortgage. 0% teaser rates on credit cards are a dime a dozen right now. Citi Diamond Preferred currently offers (as of 3/1/2016) a 21-month 0% APR balance transfer with a 3% upfront fee. Chase Slate offers 15-month at 0% APR with no fee. What this means is that you can essentially take out $10,000 in debt on a credit card, transfer it to Chase and have it for free for 15-months. This strategy contains a certain amount of risk (if you don’t have the money to pay back after the 15-months or can’t make minimum payments) but allows short-term flexibility for payments like cars and houses or longer-term investments like stocks.

What is a Decline Reason?

Common Credit Card Terms

Secured vs. Unsecured Debt

Auto Finance

Mortgage 

Budgeting

Credit

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