Leverage can be described as "using borrowed money to make more money than it costs to use borrowed money" and makes up one of Thrive's five key investment concepts.
Put simply, leverage is using the banks' money to make money for yourself. So, how can we achieve this?
Leverage comes from the ability to access borrowed money and this can be broken down into three key concepts:
Character
Security
Serviceability
Character
The vast majority of people have no problem meeting the character requirements because they pay their bills, do what they say they'll do, and act in good faith. The character test is run by the banks to qualify that the prospective purchaser will pay back the mortgage as the terms are agreed upon.
Security
For residential investment properties, security is all about having headroom between the value of your property and the maximum lending-to-value ratio. For your own home, you can borrow up to 80% of its value and for any existing properties, you can borrow up to 60% of the value.
Complications rise when you spread your borrowing across different lenders but if done right, this will allow you to access more capital without increasing the interest rate risk. Likewise, having a mix of growth and yielding properties allows you access to the optimal amount of leverage based on sufficient equity and serviceability.
It is also worth noting that banks will only secure your mortgage against quality assets that they believe they can sell to re-claim their money in the event the loan doesn't get paid. For instance, it's unlikely banks will accept a tiny house as security because its not fixed in one place and has no land therefore making it a risk security from the banks persepctive.
Serviceability
Quite often the main hurdle for investors, serviceability refers to your ability to service the mortgage you're trying to draw down.
Again, this is heavily influenced by the split between growth and yield properties. Choosing properties with strong cashflow even though the captial gains prospects are less rosy than other options can make sense because it enables you to increase scale. This trade-off is central to building a property portfolio.
Equity is the difference between the value of your property and the mortgage outstanding. As the value of your properties grow, your equity does too and when its not being used, it is essentially dead money.
The power of leverage ultimately comes down to using 'dead money' in your properties to purchase assets that are expected to grow in value over time. Unless you do renovations or other fast-grwoth strategies, investors often need to do very little other than wait to build equity in their portfolio and therefore put themselves in a position to grow their portfolio.
When the properties you've purchased go up in value, you take all the gains.
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