When you leverage your real estate investment, you’re borrowing capital, or money, in order to pay for that investment. When you take out a mortgage to buy a Southwest Michigan property instead of paying for it in cash, you’re leveraging that real estate investment. It’s a valuable tool, whether you’re investing in one property or building an entire portfolio. However, it also comes with risk, so make sure you understand what you’re responsible for before you over-leverage an investment.
Benefits of Leveraging Your Real Estate
Perhaps you want to buy a property that’s $250,000. Most lenders will require a down payment of 20 percent. So, you pay the $50,000 in cash, and then borrow the remaining $200,000. That’s leveraging. Only a small percentage of your own funds were used to buy this property, and yet you’ll be earning all of the income and benefiting from all of the value when you’re ready to sell. As the property appreciates every year, the owner’s equity or net worth from the property will also grow. This is where you see that leveraging real estate can benefit you. A home does not appreciate based on the amount of your own funds that were used to buy it. So, many investors believe it’s best to leverage or borrow as much as you can and continue to earn more on your investment without having spent too much cash at the outset.
How to Leverage an Investment Property
You can leverage your investment by using a little of your own money and getting a traditional loan from a financial institution. Or, you can use real estate partners to pay for the asset without any of your own money being spent. Sometimes, sellers will offer to finance a property in which case you wouldn’t have to put any money down. Even with a standard 20 percent down payment, you receive 100 percent of the house.
How Leverage Can Hurt
Leverage comes with risk, and while it can help you in a real estate investment it can also provide some dangers. The market could take a dramatic turn, leaving you with a house that’s worth less than what you owe on it. So, if you paid the $50,000 down on a $250,000 house and in 10 years that same house is only worth $150,000, you’ve lost some money. When prices and values drop for investors, you can end up losing money. The amount you earn in rent will not cover the loss you’re taking in the home’s value.
Too much leverage can also result in a mortgage payment that you cannot afford. If your mortgage is $1,200 per month and the market turns downward to the point that you are only earning $850 in rent, you’re going to have some trouble. Some investors will end up defaulting on their loan and losing their investment as well as their credit standing.
Be smart when you’re leveraging a real estate investment. Surround yourself with professionals who can give you good advice. We’d be happy to help. Feel free to contact us at Real Property Management Southwest Michigan.
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