Are you familiar with leverage?  Have you used leverage?  If you’ve purchased a home, chances are you have.  When you made that purchase did you make a down payment of 3, 5, 10% or more?  How long ago did you purchase your real estate?  Depending on that answer you have either leveraged up or down.  It’s also dependent on where you live.  Florida?  California?  Phoenix?  Las Vegas?  Michigan?  If you bought in one of those places between 2004 and 2007, you most likely leveraged down.  If you didn’t make a down payment, you may now be in foreclosure or on your way unless you locked in a fixed rate that you could afford.  If you used creative financing, you used another type of leverage and the combination can be deadly to your finances.

Leverage according to Daniel Webster is “1) the action of a lever or the mechanical advantage gained by it, 2) effectiveness, power”.  A Lever is “an inducing or compelling force”.  I like that word, compelling.  The effect of leverage is compelling.  It creates power.  It creates the power to gain or lose.  Leverage is what caused the Great Depression.  Leverage is what you use when you buy a home using a down payment or no down payment and financing.  It is neither good or bad by itself.  It all depends on the context in which it is used.

Here’s an example.  You are buying a $250,000 home and buy it with a conventional loan in the current market.  You provide a down payment of 20% or $50,000.  Now we know it isn’t going to appreciate anytime soon, but when it does, we’ll assume the average appreciation rate for the next 7 years (the average real estate ownership period) is 5% per year.  That means that in 2016 your property is now worth $351,775.  You have a gain in simple terms of $101,775.  When you divide that number by your down payment your money is now worth a little over triple what you invested.  You have made a 204% return or an average of 29.14% per year on your cash investment.  Your investment was not the purchase price of the home, it was the amount you invested as a down payment.  That’s leverage.  Is that better than a CD?  Better than the average return of stocks over the past 80 years?  Not bad.  And you get to live in the house, use it, make it your own, not have a landlord, and get tax breaks to boot.

What if you bought that same home in 2006 for $350,000 and not soon after it nosedived and when you needed to sell in 2008 you could only get $250,000.  The $50,000 you risked now is a loss of $100,000 or a 200% loss.  Again, you used leverage, but this time it didn’t benefit you.  That is why real estate, like stocks, should be considered a long term investment.  That’s why it is important to buy wisely and make sure the mortgage you get is one you can handle under most circumstances.  That’s why it is important to have additional reserves to get you through the hard times before purchasing real estate.  We just don’t know when those hard times will hit.  We don’t know when the balloon will pop or when the balloon will rise again.  Buying real estate is a lifestyle and investment choice that has to be carefully considered.  Sometimes circumstances are out of our control, but most of the time you will be able to control your circumstances by the choices you make before buying.  It does pay to be prepared.  Leverage is why the rich get richer.  That’s why paying interest on credit cards is a bad idea.  You are leveraging your debt to the benefit of the credit card company.  This market is making people think about frugality differently.  Being frugal is smart and allows you to leverage the money you have to your benefit.  Compounding is the eighth wonder of the world.  Be a winner!

So consider your current situation and how you might use leverage.  Is it a wise choice for you?  Check out the Recommended Reading List Page to find resources that will help you learn when it is and how to control more of your own circumstances.