Investments & Financial Planning
How does leverage enter into an investment in a home or other real estate investment?
Answer:
With an unleveraged investment such as a mutual fund, your investment return is limited to the amount invested.
For example, if you invest $100,000, and it earns 11% then you earn $11,000. However, with a leveraged investment such as a home or real estate investment, your investment return represents the gross return less the cost of the borrowed money.
For example, if you make a $100,000 down payment on a home costing $500,000 you would earn zero on the $100,000 and $12,000 on the borrowed amount of $400,000, assuming a 11% gross return less an interest expense of 8%.
The higher your expected return, the greater additional benefit of leveraging.
Exercise caution, because if your leveraged investment does not perform as well as expected, you will do worse, and in fact you might lose money if the return falls below the interest cost.
For example, if you invest $100,000, and it earns 11% then you earn $11,000. However, with a leveraged investment such as a home or real estate investment, your investment return represents the gross return less the cost of the borrowed money.
For example, if you make a $100,000 down payment on a home costing $500,000 you would earn zero on the $100,000 and $12,000 on the borrowed amount of $400,000, assuming a 11% gross return less an interest expense of 8%.
The higher your expected return, the greater additional benefit of leveraging.
Exercise caution, because if your leveraged investment does not perform as well as expected, you will do worse, and in fact you might lose money if the return falls below the interest cost.
