Investing with leverage means using other people’s money to acquire property… but is that a good idea? Here are some things to know moving forward.
You used to see the phrase O.P.M. (other people’s money) all the time. The past decade has had many revisions to this thinking. After all many people were financed up to their eyeballs in debt and when the pendulum starting swinging the other direction (toward a bad economy) many people found themselves in a state of panic. Many actually lost everything.
As a result of this hardship, many have changed their school of thought and decided that leverage was not a good thing. Many are even suggesting not using leverage. So the frequently asked question is, “should I or should I not use leverage (O.P.M).”
Of course there is only one correct answer to this question. The correct answer is: depends on you, your financial position and your financial objectives.
Leverage can be a great thing and when properly used can and will make you lots and lots of money. It is only when it is abused, as it was over the recent real estate boom, that it becomes a problem. Smart leverage is great – over leveraging is BAD! You should always use the simple, rule of thumb that a lender uses.
A lender requires you to have 6 months reserves in a saving account (or similar saving position such as insurance or IRA’S etc.) Obviously the mindset is that, should there be drastic market shifts or for whatever reason a loss in revenue, you will indeed have a cash reserve that can make your monthly payment for you. Here is where it went bad in the past. Lenders required a 6 month reserve but when you bought a second, third, fourth, etc. property they looked at the same 6 month reserve. A smart investor wants to have a 6 month reserve for each and every property they own. There is a big difference in having a 6 month reserve and having a six month reserve for each and every loan you have.
Benefits of Leverage:
Today we have a unique and unprecedented opportunity. We are able to buy investment property that generates (say a 10% return). We can actually purchase this property with money we borrow at (say 5%). I know: Wow. Talk about leverage! Borrowing money and making a 5% profit on (O.P.M.)
Leverage is considered 1 of the 5 wealth building principles. This is a big one and a wonderful tool. The other 4 wealth building principals are Income, Deductions, Equity, and Appreciation and then Leverage.
I always call Real Estate Investing the IDEAL investment and is spelled out in the acronym. I.D.E.A.L. It may be wise to look at your total financial plan or even talk to you financial planner to get the best solution for you.
Investing with leverage or O.P.M. is something to consider to help you acquire the property you want, but be sure to know what your best position is and include your financial advisor in your decision.
Ready to take the leap and start investing? Make sure you check out our FREE IDEAL Cap Rate Calculator first!